Millions of Canadians receive Old Age Security (OAS) benefits, meaning that millions of Canadians may be subject to the OAS “recovery tax” or, as it is more commonly referred to, the clawback. Unfortunately, very few Canadians are familiar with that tax or how it works, and even fewer incorporate the possibility of having to pay the tax into their retirement income planning. There are, however, strategies which allow taxpayers to minimize or avoid the OAS clawback in retirement.
For taxpayers who are not yet retired, the start of such planning (as it would be in any case) is to get a sense of what one’s income from all sources will be in retirement. Where the total amount of that income approaches the level at which the clawback could apply (for 2016, that income threshold is $73,756), it is necessary to consider some planning strategies. The overall goal of those strategies is to arrange the timing and character of income received in a way which keeps the total income figure each year below the OAS clawback threshold.
The first such strategy is to use tax-free savings accounts (TFSAs) to accumulate savings which will be tapped into in retirement. Amounts withdrawn from a registered retirement savings plan (RRSP) or registered retirement income fund (RRIF), or paid to a taxpayer in the form of an annuity are included in the total income figure used to calculate the clawback. Withdrawals from a TFSA are not. While no deduction is available for TFSA contributions, such as can be claimed for contributions to an RRSP, it may still be advisable to contribute to a TFSA rather than an RRSP. Depending on the taxpayer’s circumstances, it’s possible that the tax payable by forgoing a current deduction may be less than the combined effect of tax payable and loss of OAS benefits (and other federal and provincial credits) which would result from withdrawing those funds from an RRSP or RRIF after retirement.
Taxpayers who may be subject to the clawback should also carefully consider the age at which they want to begin receiving OAS and Canada Pension Plan benefits. It’s now possible to defer receipt of such benefits anytime up until the time the taxpayer turns 70 and the later the start date, the higher the annual benefit. The taxpayer should consider whether that higher benefit obtained from deferring the receipt of benefits (especially when combined with required withdrawals from RRSP savings which will begin at age 71) will push total annual income over the OAS clawback income threshold.
Other strategies will come into play once the taxpayer is retired and receiving OAS. Taxpayers who are over the age of 71 must withdraw income from their retirement savings at a prescribed rate. While those withdrawals will be included in income for purposes of the clawback, they can be contributed to a TFSA if not needed to meet current expenses. Once in the TFSA, any investment income earned by the funds will be sheltered both from income tax and from being counted for purposes of the clawback.
Taxpayers who are married and have private pension income (generally meaning income from an employer pension, an RRSP or RRIF or an annuity, but not government source pension income) may benefit from pension income splitting. Such pension income splitting allows the higher income spouse to reallocate up to 50% of such private pension income to his or her spouse, on a “notional” basis, meaning that no actual transfer of funds is required. The transferred income is then taxed in the hands of the lower income spouse and counts as that spouse’s income (and not that of the transferor) for purposes of the OAS clawback.
There are a lot of considerations which go into structuring income in retirement, and everyone’s financial and tax situation is different. That said, however, the overall goal for most taxpayers will be to create a relatively level flow of income from year to year, sufficient to meet current cash flow needs and maximize eligibility for available tax credits and benefits, but below the threshold at which those credits and benefits will be eroded or clawed back.
