Minimizing Old Age Security Clawback

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 at least 10 years over the age of 18.

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 $516.96 per month) 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. OAS is indexed for inflation every January, April, July and October.

OAS clawback

The OAS clawback means that high-income earners (over the age of 65) are required to repay some or the entire OAS pension. It is interesting to note that the government does not use the word clawback. Instead they use the OAS recovery or OAS repayment. Despite that clawback seem sot be the more universally understood term.

If your net individual income is above a set threshold ($66,335 for 2009), 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 $70,000, then you would be above the clawback threshold by $3,665 which in turn would mean that you would lose $549.75 per year of OAS or $45.80 per month. If you qualified for the maximum OAS, you would be losing just under 9% of your OAS pension income.

Is OAS clawback a big issue?

On one hand, the answer is yes because it is like an additional 15% tax on top of the current marginal tax rates. 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.

In terms of planning, if you are one of these people who face losing some of the OAS due to clawback because your income over the age of 65 will be higher than $66,335, then you need to consider some simple strategies to help you minimize the clawback.

1. Spend RRSPs before you turn 65. I know this sounds like unconventional advice but leaving the RRSPs until after the age of 65 may lead to the loss of OAS which is like an additional 15% tax. One of the benefits of investing in RRSPs is that it is a tax deferral. And while tax deferral is great, it is only good to a point.

2. Income splitting in retirement. Probably the biggest impact for retires with spouses was the introduction of pension splitting in 2007. With pension splitting, spouses can give up to 50% of their pension income to their spouse for tax splitting purposes. This is a very effective way to reduce income if you are close to the OAS clawback threshold. For retirees with no pension income, RRIF and annuity income qualify for pension splitting after the age of 65. Splitting or sharing Canada Pension Plan (CPP) is another income splitting strategy that can help minimize or avoid OAS clawback.

3. 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. Mutual fund corporations may be an effective alternative to convert income into capital gains as opposed to interest income.

4. Dividend income is considered tax efficient because it enjoys a much lower tax rate than interest and at some levels capital gains. The problem with dividend income is the process to getting a tax break includes a dividend gross up before the application of the dividend tax credit. As a result, dividend income can actually get you closer to the OAS clawback threshold because the grossed up income is used. If you income is close to the OAS threshold, be careful about selecting investments that produce dividend income.

5. Use Tax Free Savings Accounts (TFSA) – Tax free savings accounts are much more favourable that non-registered investments simply because the investment income is non-taxable inside the TFSA. Maximizing the TFSA is a great strategy to reduce OAS clawback especially if the investment income would put you over the $66,335 threshold. The TFSA is also a great place to hold investments that produce dividend income if those types of investments are preferred.

6. Although I am not a he fan of leverage, borrowing to invest can help reduce OAS clawback if the interest on the loan is tax deductible. This interest deductibility 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.

7. Watch for capital dispositions after the age of 65. For example, people with rental properties, cottages, or significant unrealized capital gains from investments may be better off triggering those gains before the age of 65. Triggering them after 65 may result in losing OAS from clawback.

My Two cents

At the end of the day, more people's concern over OAS clawback will not be such a big deal simply because there are not a lot of people over the age of 65 making more than $66,335 of income. The people that do may have significant pensions or continue to work and earn and income over the age of 65. There will also be a group of people that trigger significant capital gains from the sale of second property or investments but the good news is they will only lose part or all of there OAS in the one year that the capital gains is realized and reported on the tax return. But if you happen to be one of the few that will get affected, make sure you plan ahead accordingly.