Old Age Security (OAS) clawbacks are usually the last thing younger retirement investors think about, but according to Statistics Canada, more than 500,000 seniors or 8.3 per cent of total OAS recipients have been touched by the claw from Ottawa.
Its official name is the Old Age Security pension recovery tax and it starts to kick in when the annual taxable income of a recipient reaches a certain threshold. In 2024, that threshold is $90,997 but it changes each year.
If your income exceeds the threshold amount, you must repay part of your entire OAS pension according to a preset formula from the Canada Revenue Agency (CRA). The more your income exceeds the threshold, the bigger the clawback.
OAS clawbacks are normally the result of contributing too much to your registered retirement savings plan (RRSP), having those investments grow more than expected, or a combination of both.
To make matters worse, an RRSP must be converted to a registered retirement income fund (RRIF) when the plan holder turns 71 and mandatory minimum withdrawals are required based on the amount in the plan. If there is still a lot of money in the plan, the withdrawals will be taxed in a high bracket.
There are ways to avoid clawbacks and high tax bills in retirement by acting early in life. A qualified tax professional could help, but here are a few to think about:
Divert retirement contributions to a TFSA
The tax free savings account (TFSA) was originally intended as a short-term savings vehicle but as contribution limits have risen since its inception it has become an excellent retirement saving tool.
TFSA contributions can not be deducted from taxable income like an RRSP, but withdrawals are never taxed.
Striking the right balance between your RRSP and TFSA over time will permit you to withdraw from your RRSP at a lower tax rate and top up whatever other funds you need from your TFSA.
Invest through a non-registered trading account
TFSAs and RRSPs both have contribution limits. If your RRSP is growing too quickly and your TFSA is maxed out, it might be time to invest through a non-registered trading account.
The perks are not as generous but only half of the capital gains on equities sold are taxed, and capital losses on equities sold can offset capital gains paid over the three previous years or any future capital gains.
Tax credits are also available to apply against dividend payouts from eligible corporations in non-registered accounts.
Income splitting between spouses
At 65 years old married couples can share their income tax burden by shifting up to fifty per cent of the income from the higher-income spouse to the lower-income spouse (at the lower tax rate).
Younger couples can take action to balance their taxable savings pre-emptively through a spousal RRSP, where the higher-income spouse contributes to an RRSP belonging to the lower-income spouse.
A spousal RRSP also permits the higher income contributor to deduct their contribution for bigger tax savings at their normal rate.
Draw down more aggressively in early retirement
Large RRSP and RRIF withdrawals can also be avoided by making larger drawdowns in early retirement; even if it means getting some of it taxed at the next highest rate. It’s better to take it on the chin at 30 per cent than 40 per cent, for example.
Extra cash can be put in more tax efficient investment vehicles like the TFSA.
It’s important to make sure that extra cash remains invested, however. Taking too much out early to save tax leaves less time for investments to grow and less money if the plan holder lives to a ripe old age.
The most tax efficient option: retire early
The most efficient way to lower your income tax is to lower your income. If your RRSP has exceeded expectations consider early retirement. The time you gain for yourself is priceless and non-taxable.
It’s important to keep in mind that having too much money is a good problem to have.