The Old Age Security (OAS) program is the cornerstone of Canada's retirement income system. It includes a basic pension that goes to almost all people 65 or older who have lived in Canada for a certain time and is indexed for inflation every January, April, July and October.
How much income to expect
The amount of OAS you receive depends on the number of years you live in Canada after you turn 18. Generally, you receive a full pension (Currently the maximum OAS income is $466.63) if you live in Canada for at least 40 years after age 18. If you live here for less time, you may qualify for a partial pension. With a partial pension, you'll receive 1/40th of the full pension for each complete year you live in Canada after you turn 18.
If your net individual income is above a set threshold (currently $57,790), your OAS pension will be reduced. This figure is also adjusted each year for inflation. For every dollar ($1.00) of income above the threshold, the amount of basic OAS pension reduces by 15 cents. For example, if your taxable net income was $68,000, then you would be above the clawback threshold by $8210 which in turn would mean that you would lose $1231.50 per year of OAS or $102.63 per month. If you qualified for the maximum OAS, you would be losing 22% of your OAS pension income.
In my conversations with retirees, many are concerned about the OAS clawback. However, according to Human Resource Development Canada, only about five percent of seniors receive reduced OAS pensions, and only two percent lose the entire amount. If you are one of these people who face losing some of the OAS due to clawback, here are some simple strategies to help you minimize the clawback.
- Defer RRSP income. Eventually, RRSPs must be converted to income. In fact, the latest you can defer an RRSP is December 31 in the year in which you turn 69. For those concerned about the clawback, defer converting RRSPs for as long as you can and then take the minimum withdrawal each year to minimize your net income.
- Use the younger spouses age. For RRIF planning, if you are trying to keep your income as low as possible to avoid the clawback, make sure you use the younger spouses age to calculate the minimum income. The younger the age, the lower the income.
- Tax efficient income on non-RRSP investments. When it comes to investment income from non-registered investments, different types of income are taxed differently. Interest income from Guaranteed Income Certificates (GICs) and term deposits are fully taxed. However, dividend income and capital gains enjoy a much lower tax rate. One strategy is to minimize GICs and term deposits, and instead purchase income funds, that have a lower inclusion rate.
- Use part of your non-registered funds to purchase an annuity. Using part of your non-registered funds to purchase an annuity provides you with a lifetime stream of income. From a tax perspective, only a portion of each payment is taxable because a portion of each payment is considered a return of capital and is therefore tax-free. Only the portion that is interest is taxable.
- Income splitting. If you have a spouse and you are able to split your income with your spouse, you may be able to reduce your net income. Some examples include CPP splitting, investment income and payments from corporations.
- Look for all available tax deductions. The goal to reducing clawback is to reduce your income. Ensure that you claim all available deductions for your situation. When in doubt, seek help to see if you are missing some important deductions to lower your income and minimize clawback.
- Final RRSP contribution. If you are not yet age 69 and have unused RRSP deduction room, make a final RRSP contribution. You don't have to take your deduction all at once; you can spread it overtime, even beyond age 69. For example, a $40,000 deduction taken over 8 years will reduce your net income by $5,000 each year. Borrow to Invest.
- Borrow to invest. If you have discretionary income, take an interest-only loan. Loan Interest for investment purposes is fully deductible and you use the discretionary income to pay the interest. The loan interest reduces your net income dollar-for-dollar, and at the end of the loan, you pay the principal on the loan and keep the after-tax investment income. This strategy can increase significantly the value of your estate.