Avoiding the Old Age Security claw back is typically a top priority for retirees and their advisors. Understanding how different types of investment income can affect your OAS benefit is vital when trying to keep your income under the clawback threshold.
What You Need to Know
How the Clawback Works
It’s important to first understand how the OAS clawback works. The OAS has a minimum and maximum threshold for the clawback provision. The minimum is $75,910 for 2019. This means that when your income reaches this amount, every dollar that is earned over and above $75,910 claws back 15 cents of your OAS. The maximum threshold for 2019 is $123,386. Once your income reaches this amount you will no longer receive an OAS benefit.
Toms reported income for 2019 will be $76,910. This is $1,000 over the minimum threshold for OAS. As a consequence, Tom will have 15 cents for every dollar over the threshold clawed back from his OAS. Therefore, he will lose $150 of his OAS benefit.
The CRA uses the income reported on line 234 on your T1 general tax return to determine your income and therefore the clawback every year.
How Investment Income Affects the Clawback
Choosing investments that have the least effect on your OAS seems like an easy call. At first glance, interest income would make obvious sense. This is because interest income is treated as pure income. It is added to your taxable income for the year and taxed accordingly. Dividend income, however, is grossed-up 38% before it is added to your taxable income from the year. Therefore, if you earn $1 of dividend income you have to add $1.38 to your income for the year. This can significantly increase the amount of OAS you have clawed back.
Does this mean that you should switch your portfolio into interest earning investments to avoid the clawback? Not so fast. In many cases the tax efficiency of dividend income far outweighs the benefits of keeping your OAS clawback to the minimal.
Jane collects maximum CPP and OAS benefits as well as having pension income. Her reported income from these sources will be $78,000 for this year. She also receives $10,000 in eligible dividend income. The dividends will have to be grossed up 38% and added to her income. Therefore, her income will now be $91,800. Her marginal tax rate is 31.48%. She wonders if perhaps having interest paying investments would do a better job of protecting her OAS.
With her dividend income, Jane will have to pay back $2383.50 of her OAS this year [(91,800-75,910) x .15=2353]. If Jane had $10,000 of interest income, she would only have to payback $1813.50 of her OAS [(88,000-75,910) x .15=1813.50].
However, it is also important to look at the amount of tax Jane will pay with each type of income. Janes tax rate is 31.48%. Therefore, if she had interest income then she would pay $27,702.40 ($88,000 x 31.48%).
With dividend income, Jane would pay only $26,825.88 [(91,800 x 31.48%) – (13800 x 15.02%)].
Janes tax savings are $876.52 by going with dividend income. As the discrepancy between the OAS claw backs amount is only $570 (2383.50-1813.50), Jane will have more money in her pocket if she uses dividend income.
As is evident from the above example, it is important to crunch the numbers when it comes to investment income and the OAS clawback. What seems most obvious may not actually be the most efficient option. Each individual’s situation will differ and it’s important that investors work with their advisors to figure out which type of income will maximize the money they have in their pockets each year!