We’ve just finished the RRSP season when many Canadians make a last-minute contribution to beat the deadline for a deduction on their 2019 income taxes.
An RRSP is not only a great way to defer taxes, but also an essential retirement saving tool for most Canadians. However, many who have built up a large RRSP, along with other retirement savings, worry it will mean their Old Age Security pension will be clawed backed by the federal government.
While that’s a legitimate concern, there are strategies you can use to avoid or reduce the clawback.
First, let’s look at the numbers. Eligible Canadians can begin collecting OAS when they turn 65. The clawback—formally known as the OAS pension recovery tax—is based on your net income in the previous calendar year and is indexed to inflation.
For 2020, it will be triggered when net income hits $79,054. For every dollar above that threshold your OAS benefit is reduced by 15 cents. That means an individual who is eligible for the current maximum pension of $613.53 a month at 65 would have their entire OAS clawed back when their net income reaches $128,137.
Now, how might you stay out of the clawback zone or at least limit its impact on your OAS?
- Split your pension income—Pension splitting allows a higher-income spouse to lower his or her tax bill by transferring up to 50% of eligible pension income to a spouse. Reducing your pension income can lower or eliminate the clawback.
- Defer your OAS—If you’re still working past age 65, deferring your OAS can be a good strategy for a number of reasons. For every month you defer taking your OAS, your payment increases by 0.6%. So, by deferring for the allowable five years (until you turn 70), you will increase your monthly benefit by 36%. When you stop working and your income declines, you’ll receive a larger benefit and will be less likely to trigger a clawback. If you defer all the way to age 70, the higher, deferred OAS payment means that your income would have to exceed $143,345 for the OAS to be fully clawed back.
It’s important to remember that the government automatically enrolls you to receive OAS and GIS when you turn 65. You will receive a letter to that effect after your 64th birthday. So, if you wish to defer your OAS you must inform Service Canada before your 65th birthday.
- Keep your TFSA topped up—Unlike RRSPs, withdrawals from tax free savings accounts are not treated as taxable income. As such, you can top up your income from your TFSA to meet your lifestyle needs while keeping your income below the clawback threshold.
Everyone’s situation is different and some of these strategies come with caveats and require complex calculations. A good financial plan that includes income tax projections will help clarify where you stand on this and other retirement issues.
In the end, there may be no other option but to forgo some or all of your OAS. At that point, it’s important to remember that if you’re being clawed back, it’s because you have a very healthy income, which is something to be grateful for.