Maximizing Old Age Security

At this time of year many income tax returns have just been filed, and seniors will have found out how much of their Old Age Security (OAS) they got to keep.

Old Age Security payments are “clawed back” at a rate of 15% when net income exceeds a certain threshold ($67,668 in 2011). This means that when an individual’s net income is less than $67,668, he or she will be eligible for the full amount of the OAS annual benefit — $6,368.25, in 2011. For each dollar of net income over the $67,668 threshold, an individual’s OAS benefit amount is clawed back by $0.15. The full amount of OAS benefit is clawed back when an individual reaches $110,123 of net income [$67,668 + (6,368.25/15%)]. A senior who earns $80,000 of net income will be entitled to $4,518.45 of OAS benefits, and will have to pay back the difference between what was received ($6,368.25 – 4,518.45 = 1,849.80), unless an amount was withheld at source.

So how does a senior plan his or her affairs to keep more of the OAS benefit?

Review the type of investment income

After consideration of the individual’s investment risk profile, many non-registered investment portfolios are set up to be “tax efficient”. Tax efficiency can be achieved by taking into account the different tax treatment afforded to different types of investment income when designing an investment portfolio. Some types of income — capital gains and dividend income, for example — are taxed at a preferred rate when compared with regular income. Only 50% of a capital gain is included in income. Dividends are subject to a gross-up, but the taxpayer is entitled to a dividend tax credit. Interest income is not eligible for any special treatment and is taxed at the individual’s regular rate of tax.

The structure for taxing dividend income works against seniors with respect to the Old Age Security clawback because dividends are grossed-up for the calculation of net income while the offsetting dividend tax credit is integrated at a later point in the tax return.

For example, eligible dividends (generally, dividends from public companies) are grossed up by 41% to arrive at the income amount, so that the taxpayer reports 141% of the actual dividend received as income. Eligible dividends generate a federal dividend tax credit of 16.44% of the grossed-up amount, which ultimately reduces the tax associated with the dividend. However, because the OAS clawback is based on the individual’s net income amount, the formula for taxing dividends creates an artificially high net income amount that results in a higher clawback than would be triggered if the income was from another type of investment.

Ineligible dividends (private company dividends taxed at the low rate) are subject to a 25% gross-up and generate a federal dividend tax credit of 13.33% of the taxable amount; thus, they have less impact on the OAS clawback (but a higher net tax rate).

While eligible and ineligible dividends are taxpreferred types of income and result in less overall income tax than interest income, the impact on an individual’s eligibility for OAS is more subtle. From a planning point of view, seniors should understand this interplay when assessing investment decisions.

Divide, Defer and/or Deduct

The three “D’s” of tax planning are: Divide, Defer and Deduct. These rules create the stage for numerous planning strategies that seniors can employ to lower their net income and therefore retain more of the OAS benefit.

Divide

Spouses can divide pension income under the pension income splitting rules. Spouses can sometimes share non-registered investment income by utilizing carefully structured loan strategies between them or perhaps other family members. Canada/Quebec Pension Plan payments are eligible for sharing between spouses, upon application to the government. Income earned in a Tax Free Savings Account (TFSA) is not taxable, so it is important to maximize any opportunity where using a TFSA might help lower net taxable income. There may be times where a senior wants to distribute some of his or her capital to intended (adult) beneficiaries early, which would remove the associated investment income.

Defer

Where other income provides adequately, seniors could defer the receipt of RRIF payments as long as possible. Then, by the time he or she is required to begin minimum RRIF payments, there may be fewer non-registered assets to generate taxable investment income, so the impact on the net income may be lower. Spend non-registered money first, and maximize any deferral opportunities associated with a RRIF or RRSP.

Deduct

Deduct eligible interest expense on any borrowed funds used to invest, and eligible investment management fees.

Incorporate

Seniors may want to consider moving their investment portfolio inside a holding company. This would move the associated investment income from the taxpayer’s personal income tax return to the corporation’s income tax return. By removing the investment income from the personal tax returns, the taxpayer’s net income could be reduced by an amount that would allow the retention of some or all of the Old Age Security payments.

Income could be drawn from the holding company by paying down the shareholder loan created when the investment portfolio was transferred into the holding company or by strategically paying dividends, bearing in mind the impact on the Old Age Security claw back formula.

The strategy of incorporation will depend on the amount of OAS benefit involved, the client’s desire to retain the OAS payment, and other broader planning undertakings being taken within the family. This type of strategy is typically more sophisticated and is better utilized for larger investment portfolios, but keep in mind that the costs of incorporation and bookkeeping/tax filing could approach or exceed the amount of OAS otherwise clawed back. Additionally, there may be tax consequences of the transfer of assets into the corporation, and eventually of winding up the corporation if it gets too small to be worth the added fees and costs.

Planning to retain more of the OAS benefit could also assist in the retention of the federal age credit and provincial tax credits. It is always important to ensure the benefits derived exceed the cost.

E.O. & E.

Disclaimer:

This commentary is published by the Institute in consultation with an editorial board comprised of recognized authorities in the fields of law, life insurance and estate administration.

The Institute is the professional organization that administers and promotes the CLU and the CHS designations in Canada.

The articles and comments are not intended to provide legal, accounting or other device in individual circumstances. Seek professional assistance before acting upon information included in this publication.

Advocis*, the Institute for advanced financial education.

(The Institue”), CLU, CHS, FHF.C and APA are trademarks of the financial advisors Association of Canada (TFAAC).

The institute is a wholly-owned subsidiary of Advocis. Copywrite TFAAC. All rights reserved. Unauthorized reproduction of any images or content without permission is prohibited.

Copywrite  ISSN 0382-7038

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.

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About The Author

Mark Schneider
Mark Schneider is one of Canada's leading Chartered Financial Planners. For over 30 years he has helped hundreds of regular Canadian families grow small fortunes through consistent planning and wise advice. He holds the following designations: CFP, CLU, CHFC, CFSB

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