Review of OAS and strategies to reduce impact of the OAS clawback

Old Age Security (OAS) benefits are available to anyone in Canada 65 years of age and older as long as they meet specific residence requirements. You do not need to be retired and employment history is not a factor when determining eligibility. The Old Age Security program is financed from Government of Canada general tax revenues. The maximum OAS pension is currently $546.07 per month.

For information on the eligibility requirements, visit http://www.servicecanada.gc.ca/eng/isp/oas/oasoverview.shtml.

When you are on the home page for OAS, click Find out more about the OAS changes in Budget 2012 on the right side of the page. This link provides you with changes made to the plan in 2012. One of the main changes is that the Government of Canada plans to gradually increase the age of eligibility for the OAS pension between the years 2023 and 2029, from 65 to 67. People currently receiving OAS benefits will not be affected by the changes. I was born in 1959 and thought that I would not be able to apply for the OAS pension until age 67. I was pleased to find out that I can apply at age 65 plus five months; therefore, I don’t have to wait until age 67.

Many people are concerned that once they are receiving OAS, a portion or all of their benefit might be “clawed back” if their income is too high. This clawback policy started in 1989 in order to reduce the benefit to those whose net income exceeds a specific annual threshold. In 2013 the threshold is $70,954. The annual benefit is reduced by 15% of the amount that the net income exceeds the threshold amount. For anyone whose net income exceeds $114,640 in 2013, the full amount of OAS is clawed back.

The clawback amount takes effect every July through June, taking into account the income for the previous calendar year (January through December). For example, if your net income in 2013 exceeds $114,650, your entire OAS benefit will be clawed back effective July 2014 to June 2015 (you will not receive an OAS benefit for one year). At the end of 2014, your net income will be reassessed which will determine your OAS benefit staring in July 2015.

It is important to consider all your income sources as you approach age 65. For example, if you are collecting OAS, CPP ($1012.50 is the maximum), a company pension of $25,000, have an RRIF of $200,000, and a non-registered account of $100,000, you would need to total these amounts:

Your total income would be $56,702.84, which is starting to get close to the clawback threshold.

The following are some strategies to reduce your net income and the impact of the OAS clawback:

• When to start your RRIF. Delay the conversion of your RRSP to a RRIF or annuity until age 71 to keep your net income as low as possible, as long as possible. There will be a minimum amount that will have to be withdrawn from an RRIF as soon as it is set up and the annuity will produce a monthly payment. Either of these coupled with OAS, CPP, and other pensions may push your net income over the clawback threshold.
• Age of spouse RRIF. When opening an RRIF, base the withdrawal schedule on the age of the younger spouse. This will reduce the minimum amount that will have to be withdrawn each year, therefore reducing net income.
• RRSP withdrawals. You may wish to withdraw some RRSP funds prior to age 65, especially in a year when your taxable income is expected to be low. Any funds withdrawn from your RRSP have to be claimed as income for that year, so by withdrawing funds prior to age 65 you will reduce your net income later on. Some people may not want to withdraw any funds from their RRSP between the ages 65 to 71 in order to minimize the effects of the clawback.
• Apply to receive CPP/QPP as soon as eligible. The standard age that most people apply for CPP/QPP is age 65. At age 65, the maximum amount that you could receive from CPP/QPP is $1012.50 per month. Everyone has the option to apply at age 60 and receive a reduced benefit. Starting in 2012 to 2016, this early pension reduction will gradually increase from 0.52% to 0.6% per month. This means that if you start receiving your CPP pension in 2016 at age 60, your pension amount will be 36% less than it would have been had you taken it at age 65. You may want to keep your CPP/QPP benefits as low as possible so that your total net income does not exceed the threshold when you reach age 65 and become eligible for OAS.
• CPP splitting. If you have a spouse receiving a higher CPP benefit, they can apply to share their CPP/QPP benefits with a lower income spouse, which will reduce their net income.
• Income splitting. If you are 65 or older, the higher income spouse can also report a portion of their RRIF, employer pension, or annuity in the name of the lower income spouse to reduce net income.
• Make use of your TFSA account. Income generated in your TFSA isn’t taxable nor are withdrawals from your account.
• GIC and bond interest. GICs and bonds pay interest which is taxed at a higher rate than capital gains and dividends, so it is wise to even out your investment income. If you have GICs in a non-registered account you may want to consider a semi-annual or annual payout rather than compounding until the end of the term. For example, if you had $200,000 in a 5 year GIC paying 3% (compounded) paying interest at the end of the term, you would have to include interest of over $30,000 in your income at the end of year five. Compare this with an annual payout of $6,000.00 for the same GIC. Some institutions offer a high rate of interest on a compounding GIC, but do your calculations first to see how much income you are going to have to report at the end of the term. Any additional percentage that you receive on compounding may result in a clawback.
• Capital gains. You may want to trigger capital gains on cottages, rental property, and non-registered investment prior to age 65. If you are over 65 and have a capital loss to carry forward on mutual funds or stocks, you can use this to reduce capital gains claimed for that year.
• Dividends and taxable income. In your non-registered accounts, dividends incur less tax than interest. However you must “gross up” the amount of dividends you received in a way that increases your taxable income. For example, someone earning $1,000 in dividends now reports $1,450 in income on his or her tax return. They will be able to claim a dividend tax credit, but this may not compensate for any clawback of OAS. Prior to turning age 65, review your portfolio of dividend paying stocks and calculate what the grossed up value of your dividends will be for the year you begin collecting OAS. One strategy to reduce your taxable income is to have all your dividend paying stocks invested in a joint account. Then you can claim all dividends in the name of the spouse with the lowest income. If one spouse is under the age of 65, consider having the dividend paying stocks in the name of the younger spouse that is not yet collecting OAS. As most people age, they also prefer to lower the risk in their stock portfolio by re-balancing in the direction of more bonds and GICs. Although you must include all the interest in your taxable income, you do have more control over when the interest will be paid to you by laddering the terms of your bonds and GICs.
• Defer OAS for up to 5 years. Starting July 1, 2013, you will be able to voluntarily defer receipt of OAS for up to 5 years. You will receive an increased amount of 0.6% to your OAS pension for every month you delay receipt, up to a maximum of 36% (60 months) at age 70. For example, someone who is going to turn 65 in December 2013 and decides to delay receiving their OAS pension of the full five years (the maximum deferral period) their monthly pension amount would increase by 36% at age 70. (0.6% x 60 months)
• Mutual fund year end capital gain distributions. Be cautious of mutual funds that have large capital gain distributions in December. You don’t have any control over how much capital gain per unit will be paid out and this gain will have to be reported in your taxable income. When choosing mutual funds, check the fund’s past distribution history.
• Mutual fund monthly income distribution. Be aware of whether your mutual funds pay monthly income as interest, dividends or capital gains in your non-registered investment accounts. You only need to include 50% of the capital gain in your income for the year, 100% of interest income, and the grossed up amount of dividends as discussed in an earlier point. Your strategies could include having the lower income or younger spouse (under age 65) hold the mutual funds.

The majority of Canadians do not have to be concerned about the clawback. However, I would suggest that anyone approaching age 65 review their sources of income to allow themselves the opportunity to take advantage of the strategies outlined in this article to lower their taxable income.

About the author: The author has completed the Canadian Securities Course and Professional Financial Planning and has worked in investment services for about 6 years.