Articles on Saving and Investing
What is Old Age Security Clawback?
Old Age Security ("OAS") is a social insurance program that provides a basic level of pension income, on application, to anyone age 65 or over who meets residence requirements.
The amount of Old Age Security pension is part of taxable income. OAS is reduced for persons with high income through a recovery provision of the Income Tax Act.
For 2007, the tax recovery applies to persons whose net income exceeds $63,511. For each $1 of income above this limit, the amount of basic Old Age Security pension reduces by 15¢.
Repayment of "clawed-back" OAS pension is made through deductions at source. If net income is more than $63,511, one-twelfth of the total estimated repayment for the year will be deducted from your monthly OAS payments. The estimated repayment is based on your previous year's tax return.
Various sources of income are necessary for a comfortable retirement, including a registered retirement savings plan (RRSP), locked-in retirement account (LIRA), the Canada (or Quebec) Pension Plan, a company pension and non-registered investment income and/or capital.
OAS recovery is based on net income, that is income after deductions. One way to minimize clawback is by earning types of income that have less than a 100% inclusion rate. Another way is by using all possible tax deductions.
Generate Tax-Efficient Investment Income
Income from a company pension or the Canada Pension Plan is fully taxable. There is no flexibility there. However, with a registered retirement income fund (what are RRSPs converted to after age 69), you have the ability to take a minimum withdrawal each year to minimize your net income.
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, capital gains enjoy a much lower tax rate. While dividend income is taxed at a lower rate after taking into account the dividend tax credit, the "grossed-up" amount actually increases net income and will cause to increase OAS recovery payments.
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 not only provides you with a lifetime dtream of income, only a portion of each payment is taxable. This is 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, and is generally less than half of each payment.
Look for all Available Tax Deductions
Seek professional advice when preparing your income tax return to ensure that you claim all available deductions for your situation.
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. You get a tax savings of up to about $2,500 depending on your marginal tax rate, and your lower net income may result in an increase in Old Age Security of as much as a $750 per year, if your net income is still above the threshold.
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 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.
What is Net Income?
Net Income is Total Income reported on your tax return less certain deductions.
Total Income includes employment income, Old Age Security, Canada or Quebec Pension Plan benefits, pension income, dividends, taxable capital gains, rental income, RRSP income and other revenues.
Deductions include Registered Pension Plan contributions, RRSP contributions, union and professional dues, business losses, carrying charges, interest expenses and other items.
Government of Canada's OAS Repayment Web Page