HNW clients and the OAS clawback

Says Jason Heath, managing director and certified financial planner with Objective Financial Partners Inc. in Markham, Ont.: “There can be some neat ways to pay less tax over your lifetime, which should be the most important consideration when you go into retirement.”

Unlike the Canada Pension Plan, which is funded by contributions during a person’s working years, the OAS pension is funded through general tax revenue. For the fourth quarter of 2019, the full amount payable to a retiree is $613.53 a month. Retirees who earn more than $77,580 in 2019 face an OAS clawback equal to 15% on amounts above that threshold. At $126,058 of income, the OAS pension is fully clawed back.

Retirees tend to place great importance on avoiding the OAS clawback, often viewing it as money they’re owed.

“I see people who have small OAS clawbacks — maybe for a year [in which the person] had some capital gains and that jumps them up to a slightly higher tax bracket and they lose hundreds of dollars on their OAS — [and] seem to be quite concerned,” says Heath, who adds that he nevertheless understands their frustration.

Some retirees, for example, consider switching from a non-registered portfolio that produces tax-efficient eligible dividends to a portfolio that produces less tax-efficient interest income with the goal of avoiding OAS clawback. Eligible dividends result in a gross-up of income before the application of a dividend tax credit (DTC). The higher reported income results in a greater loss of the OAS due to clawback compared with an equal amount of interest income.

What retirees should keep in mind, however, is that the tax savings from the DTC on the eligible dividends more than make up for the clawback to the OAS and other incremental tax costs — higher taxes before DTC, lower age amount, etc. — associated with reporting a higher income, Davis says. For example, in Ontario, the tax savings of $3,453 on the combined federal/provincial DTC associated with $10,000 of eligible dividend income is greater than the associated loss of $570 due to clawback and $1,091 in incremental taxes. (All figures apply to the 2019 tax year.)

“OAS clawback is definitely a real cost,” Davis says, “but if we look at the big picture, you [may be] better off overall with eligible dividends than, say, interest.”

In addition, the tax costs associated with restructuring a portfolio — for example, by selling equities in order to invest in a return-of-capital investment to achieve lower taxable income and mitigate the effect of OAS clawback — could be higher than the potential savings.

“If you’re looking at high net-worth (HNW) investors, we could be looking at [triggering] thousands or hundreds of thousands of dollars’ worth of capital gains [in order to restructure a portfolio],” Davis says. “That just might not make sense to try to recover $7,000 or $8,000 of OAS income.”

Nonetheless, there are many effective ways to reduce or eliminate OAS clawback as part of a comprehensive retirement and estate plan, particularly if planning begins well ahead of time.

For example, high-earning people might consider drawing down strategically from their RRSPs while deferring taking OAS until age 70. Doing so will allow these taxpayers to “smooth out” taxable income over time while qualifying for higher OAS later. Deferring OAS until age 70 results in a 36% higher pension benefit compared with taking it at 65.

“Once you begin taking OAS, unless you cancel it [in writing] with the government within six months, you’re in,” says Ashley Searle, wealth and estate planning specialist with Canaccord Genuity Corp. in Calgary. HNW retirees who may otherwise feel resigned to losing the OAS completely might consider deferral. “They may actually start seeing some of those [OAS pension] payments [later],” Searle says.

Retirees concerned about the OAS clawback also might consider investments that provide a reliable stream of income, part of which could be returns of capital gain, says Carol Bezaire, senior vice president of tax, estate and strategic philanthropy with Mackenzie Investments in Toronto. “Some of your money comes back as return of capital, and the rest will be accounted [for] as capital gain or loss,” she says. “That compares very well with dividends, when you get to the clawback area.”

Heath may suggest to certain HNW clients who have sufficient pension income and large amounts of assets held in non-registered accounts that these clients set up a discretionary family trust. The retiree may be able to split income effectively with family members via the trust, particularly with grandchildren, who are likely to be in lower income-tax brackets. Contributing assets to the trust also will lower the retiree’s income and perhaps mitigate or eliminate the risk of OAS clawback.

“[A discretionary trust] can be a great way to accomplish a number of goals for the right person,” Heath says.