Converting RRSPs takes planning

Many baby boomers have multiple sources of wealth, Bezaire says. Entre-preneurs can take money out of their companies, she says, while others might have family trusts and inheritances.

“I think OAS is going to be a bigger deal for [those clients],” Bezaire says, “because they’re going to have a higher retirement income.”

In order for your clients to receive their full OAS benefit, they can have up to $70,954 in retirement income in 2013. Once that limit is surpassed, OAS payments must be repaid at 15% of the difference between the threshold and the client’s income. If the client’s income is $114,793 or higher, he or she is not eligible for OAS.

Withdrawals made from registered accounts, such as RRSPs and registered retirement income funds (RRIFs), are counted as retirement income and, therefore, could affect OAS benefits. If a client has a substantial registered account, mandatory minimum withdrawals from the RRIF could push the client’s retirement income above the OAS threshold, resulting in a clawback of his or her OAS benefits.

In order to avoid the OAS clawback, clients should start “melting down” their RRSPs. Generally, says Glenn Stewardson, senior financial planning advisor with Assante Capital Management Ltd. in Halifax, you should consider working with your clients on how best to draw down their RRSP accounts when they are between the ages of 45 and 55. If you wait until a client is 65, it may be too late to plan in the most effective manner.

For older clients, some RRIF income can be streamed into a tax-free savings account (TFSA), says Bezaire, in which the after-tax dollars can grow tax-free. Such a strategy complements an RRSP nicely, she says, particularly if the client has never used a TFSA before and has the full $25,500 in contribution room still available.

However, if your client has made regular contributions to a TFSA, he or she might not have enough contribution room to make this strategy viable. For these clients, says Stewardson, “you need to do something a little more radical than that.”

Clients with large RRSPs might think about withdrawing $30,000-$40,000 a year before retirement in order to avoid the OAS clawback. Clients should note that RRSP withdrawals are taxed as income and subject to withholding taxes of up to 30% and may be taxed further when they’re declared on the client’s tax return. These withdrawals do not receive capital gains tax treatment or the dividend tax credit.

In addition to the TFSA, a well-managed, non-registered account could help your clients avoid an OAS clawback.

“Don’t discount non-registered accounts,” says Doug Carroll, vice president of tax and estate planning with Invesco Canada Ltd. in Toronto. “[Clients] may, in fact, be better off earning some of that income in a non-registered account.”

For instance, in placing assets in a non-registered account, while some taxes will be paid up front, the after-tax dollars can be withdrawn at any time and be spent, says Carroll. Capital gains, which also count as income against OAS eligibility, are only 50% taxable compared with RRSPs’ fully taxable withdrawals.

Clients can also make the most of their non-registered accounts by investing in corporate-class funds, Bezaire says, which offer exposure to dividends and tax deferral. Dividends paid by stocks that are purchased directly would be regarded as income and could lead to an OAS clawback. But, Bezaire says, dividends paid within a mutual fund remain within the fund until the client redeems his or her units; in that case, the earnings are treated as capital gains. (In rare cases, a dividend fund might pay dividends to unitholders, but those amounts would not be enough to affect OAS eligibility.)

Carroll, however, warns against dismissing dividends outright: “The actual dividend is subject to the clawback calculation, which is unfortunate. But it shouldn’t cause people to shy away completely from Canadian dividend [stocks].”

The dividend tax credit, he adds, can make dividends more favourable in some cases than other investment income, such as interest or foreign-investment income.

Another option is to make a charitable donation. Taking money from an RRSP and donating it to a charity will eliminate the taxes on that investment, says Stewardson, while also melting down the RRSP to avoid the OAS clawback.

As the donations could be large, it’s important to show your clients how the strategy fits with their overall plan.

“[Clients] may be reluctant to give away that much money,” Stewardson says. “But if they have a proper plan and realize they have enough money for their lifetime, they might be willing to do so.”

If your client is close to age 65 and timing doesn’t allow for much planning, one option is to use income-splitting. By assigning 50% of the taxable income from a RRIF withdrawal to your client’s spouse, Bezaire says, your client can avoid the OAS clawback and lower his or her tax bracket.            IE