Hello everyone, and welcome to the Retiring Canada Podcast. In today’s episode, we're going to discuss how you can combat clawbacks on your government benefits and 10 strategies to mitigate or eliminate this 15% added tax.
Specifically, we will cover:
- What Old Age Security (OAS) is and how much you could receive
- What an OAS clawback actually looks like in practice
- Ways to mitigate the impact of unusually high-income years
- 10 tips to mitigate or eliminate an OAS clawback
- Lastly, a few actions items for you to consider
But before we dive into today’s episode, I have some exciting news to share! My wife and I are expecting our second child in May of next year. We are thrilled to welcome another little one into the world and are looking forward to many more sleepless nights ahead!
Today, we will unpack how you can maximize government benefits and avoid a clawback of your OAS pension. Specifically, I will focus on the Old Age Security recovery tax, often referred to as the OAS clawback. The OAS benefit is income-tested, meaning that the amount of taxable income you report on your tax return will significantly impact how much you will receive and how much you could lose.
For starters, the OAS pension is a monthly benefit you can receive if you are 65 or older. You are not required to contribute to the OAS pension plan; however, the amount you receive depends on how long you have lived in Canada.
If you have lived in Canada for less than 40 years after age 18, the amount you receive will be reduced proportionally. For example, if you start the OAS benefit at age 65 and have only lived in Canada for 20 years after age 18, you will receive only half of the pension.
In 2023, the amount is approximately $707 a month or nearly $8,500 a year. If you are 75 or older, this benefit increases to $778 a month or just over $9,300 a year.
You can also choose to delay OAS past age 65 up to age 70. For each month you delay OAS, the pension increases by 0.6%. This equals a 7.2% annual increase and a total 36% permanent increase if you wait until age 70.
Alright, with that crash course out of the way, let's discuss how you could lose some or all of this benefit and how you can fight back against the clawback.
As I mentioned before, the OAS benefit is income-tested. This means you can lose some or all of the benefit when your taxable income reaches a certain threshold. For the 2023 income year, the threshold begins at $86,912, with a full loss of the OAS benefit at $142,428 in taxable income. There is another upper limit threshold for Canadians 75 or older, which is slightly higher.
A quick note: the line on the tax return that impacts these benefits is Line 23400 – this is known as your Net Income before adjustments. This is especially important for those who think they can offset capital gains with capital losses to mitigate OAS clawback... spoiler alert, it doesn’t work.
So, what does a clawback look like? For every dollar of taxable income you report OVER the lower threshold of $86,912, you face an effective 15% increase in tax. If you report an extra $5,000 in taxable income over this threshold, this would result in a $750 loss in benefit. This would appear as a social benefit repayment when you file your taxes and a reduction in your monthly OAS benefit starting in July of that same year.
Let’s walk through that again: You file your taxes in April, and at that time, learn your income is $5,000 over the threshold. This will trigger a social benefit repayment of $750 that reduces your refund or increases your balance owing by increasing the calculation of total tax payable.
In July of that same year, your OAS pension will be adjusted downward, or in other words, clawed back. The OAS payment would be reduced by $62.50 monthly, or 1/12 of the overall $750, spanning from July through June of the following year.
Now, let’s assume the increase in income you experienced in a given year was a one-off scenario. Maybe you sold a piece of land or property, had a large capital gain in an investment account, distributions from a holding company, or some other infrequent taxable event. The social benefit repayment is still required at filing based on the income from your most recent tax year.
If you do nothing, public pensions will assume that will happen again, meaning your OAS will be clawed back proportionally during the next cycle starting in July. When you file your taxes the next year and the government learns your income is now below the threshold, you will receive a credit on your tax return dollar for dollar, increasing your overall tax refund.
Alternatively, if you don’t want to wait a full year to receive the credit on your next year’s tax return, you have the option to file a form with CRA called the T1213(OAS) – Request to reduce Old Age Security recovery tax at source. This form provides CRA an estimate of your incomes, deductions, and tax credits for the current tax year. If approved, the government may adjust or eliminate your OAS recovery tax.
In the end, whether you file this form or wait until the following year’s tax filing, it’s a wash. However, for some who prefer having the funds in their account now month to month, rather than waiting until the following year, there may be some benefit.
Alright, let’s discuss 10 ways to reduce or eliminate OAS clawbacks to keep the government out of your pocket:
1. Maximize your Tax-Free Savings Account (TFSA): If you have investments generating taxable investment income in a non-registered account, such as interest income and dividend income, ensuring the TFSA is utilized will help keep that taxable income down.
2. Optimize non-registered investments: Pay close attention to how your non-registered investments are distributing income. Interest income is fully taxable, so shifting an investment that generates primarily interest income to an already fully taxable account like an RRSP or RRIF may be beneficial. Dividends are grossed up, inflating your taxable income number on line 23400 of your tax return. While you will receive a dividend tax credit, it does nothing to reduce line 23400 as this represents your net income before adjustments like the dividend tax credit.
3. Manage accrued capital gains: Pay attention to your accrued capital gains, whether it be in a rental property, lake property, or significant unrealized capital gains from a non-registered investment. There may be merit in realizing some of these gains BEFORE you start your OAS pension.
4. Consider deferring OAS: If you expect to realize some gains as you reach 65, you may want to consider deferring OAS to a later date. This avoids a potential clawback or loss of the benefit and provides a permanent increase in the OAS pension. Even without significant gains expected, deferring to age 70 might make sense, but it’s best to run some scenarios with a professional.
5. Convert an RRSP to a RRIF early: This may seem counterintuitive, but withdrawing taxable income from these accounts before OAS can make sense in some scenarios.
6. Contribute to your RRSP: If you have the room, contributing to an RRSP account to reduce your taxable income and mitigate or eliminate OAS clawbacks can be especially important for those triggering large one-off taxable events.
7. Optimize pension income splitting: If you have an eligible pension, you can split up to 50% of the income with your spouse to reduce overall household tax and mitigate or eliminate a potential OAS clawback.
8. Consider CPP pension sharing: Apply with CRA to share your CPP pension. This requires eligibility and specific calculations but can be beneficial, especially if one spouse does not have some or any CPP pension.
9. Use T-Series investments (return of capital investments): In this type of investment structure, some or all investment income distributions are considered a return of capital, reducing your adjusted cost base. This provides a tax deferral in the early years but higher tax reporting in the later years once the adjusted cost base reaches zero.
10. Speak with a professional: If in doubt, consult a professional. A wealth manager can provide tremendous value in helping save you from an additional 15% tax rate.
When it comes to working with a wealth manager like myself, everything is a matter of tax. One of the reasons I like to go through my clients’ taxes is because it is THEIR money, and I want to ensure they are not overpaying the CRA. We look at taxes from a ten-year timeline instead of one year at a time. Even a small reduction in annual taxes can result in significant savings over a decade or more.
Alright, so that does it for today. Let's go through some action items for you to consider:
1. Develop a retirement income roadmap: See how close you are to the OAS clawback number by adding up your fixed incomes (defined benefit pensions, CPP, OAS, other taxable annuities) and other income streams (rental income, non-registered investment income, RRIF/RRSP distributions). If you’re nearing OAS clawback territory, consider the tips discussed to mitigate or eliminate the clawback.
2. Share this podcast: Share this episode with a friend or family member nearing retirement. You could help someone save a few hundred or even a few thousand dollars in unnecessary OAS clawbacks.
That’s it for today’s episode. For the links and resources discussed, please check out the link in the show notes or visit retiringcanada.ca. If you enjoyed the show, please subscribe and leave us a 5-star review on your favorite podcast app. Be sure to sign up for my weekly Retiring Canada newsletter.
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All comments are of a general nature and should not be relied upon as individual advice. The views and opinions expressed in this commentary may not necessarily reflect those of Harbourfront Wealth Management. While every attempt is made to ensure accuracy, facts and figures are not guaranteed, the content is not intended to be a substitute for professional investing or tax advice. Please seek advice from your accountant regarding anything raised in the content of the podcast regarding your Individual tax situation. Always seek the advice of your financial advisor or other qualified financial service provider with any questions you may have regarding your investment planning.