Optimizing OAS to the Circumstances
The claw-back of Old Age Security (OAS) payments has been a part of the fabric of planning for many years. Many articles discuss planning strategies designed to avoid the claw-back. However, planning should not be limited to avoiding a single tax provision or minimizing exposure to a tax at the expense of broader planning objectives; instead, it should be more comprehensive in nature, and consider the impact on the retiree’s overall situation.
One of the strategies often cited to avoid the OAS claw-back is to avoid dividends because the dividend gross-up increases net income, which in turn increases the taxpayer’s exposure to the claw-back. However, as discussed below, dividends also produce a dividend tax credit that can improve the taxpayer’s overall economic outcome. There are two types of dividends —
eligible and ineligible dividends — and each attracts a different percentage for the grossed-up amount included in net income and for the resulting dividend tax credit.
For 2014 the federal dividend gross-up for eligible dividends is 38 per cent, and the
dividend tax credit is 11/18ths of the gross-up amount, or 15.02 per cent of the taxable amount. For ineligible dividends the 2014 gross-up is 18 per cent while the dividend tax credit is 13/18ths of the gross-up amount, or 11.017 per cent of
the taxable amount.
An issue worthy of careful analysis is whether the dividend tax credit can produce greater tax savings than the tax-cost of the OAS claw-back. Consider the following example that utilizes the combined federal and Ontario tax rates:
- Column A represents the individual’s current situation where the taxpayer has $30,000 of interest income (investment income row). The individual’s total income of $70,954 is exactly on the 2014 threshold for OAS claw-back
- Column B changes the $30,000 of interest income to $30,000 of eligible dividends received. Applying the gross-up and dividend tax create to this amount increases the amount of taxes payable and triggers $1,710 of OAS claw-back. However, the application of the dividend tax credit that reduces the taxes payable places the individual in a more advantageous economic position than column A.
- Column C assumes the $30,000 of investment income is generated through the receipt of $30,000 of ineligible dividends. After the integration of the applicable dividend gross-up and dividend tax credit, the taxpayer’s net economic position is better than column A, even though the taxpayer was subject to OAS claw-back.
| A | B | C | |
|---|---|---|---|
| Other Income | 34,336 | 34,336 | 34,336 |
| OAS Income | 6,618 | 6,618 | 6,618 |
| Dividend Income | 30,000 | 30,000 | 30,000 |
| Cash Income | 70,954 | 70,954 | 70,954 |
| Gross-Up | n/a | 11,400 | 75,400 |
| Total Taxable Income | 70,954 | 82,354 | 76,354 |
| Taxes Payable | 15,315 | 19,061 | 16,992 |
| OAS Claw-back | Zero | 1,710 | 810 |
| Dividend Tax Credit | Zero | 9,218 | 5,493 |
| Net Taxes Payable | 15,315 | 11,553 | 12,309 |
| Net Cash Position | 55,639 | 59,401 | 58,645 |
The above example highlights the fact that the overall income tax liability could be less even though the individual was subject to OAS claw-back. Each client situation is unique with respect to the amount of income, the type of income, and the province of residence — all which should be taken into consideration in tax planning.
Another claw-back that has to be considered by retirees is the tax credit for individuals 65 or older. The federal government age amount of $6,916 is reduced by 15 per cent of net income in excess of $43,873, and is completely eliminated at a net income in excess of $80,890.
The OAS claw-back is an important tax that needs to be observed in planning for retired individuals. However, simply putting in place those strategies that avoid the tax may not be the most efficient strategy for the client. Planning should look at the individual’s total profile in devising customized recommendations.
E.O. & E.
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Contributors to this edition:
James W. Kraft, cpa, ca, mtax, tep, cfp, clu, ch.f.c.
Deborah Kraft, mtax, tep, cfp, clu, ch.f.c.
