The tax tip all retirees should know

Watch out for the dreaded Old Age Security clawback

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From the April 2016 issue of the magazine.

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retirement

(Lee Edwards/Getty Images)

One useful year-round tax tip for retirees that’s always worth repeating—and often ignored!—is to watch out for the dreaded Old Age Security clawback once you starting collecting government benefits. The more your income exceeds $72,809 in 2015, the smaller your OAS cheque will be (earn more than $118,055 and you won’t get a payment at all). This is important to keep in mind because if you want to avoid that clawback you may have to do some careful tax planning, such as removing money from an RRSP earlier than later. Many people make the mistake of keeping their savings in an RRSP until they have to convert to a RRIF starting at age 71. Once that happens, forced annual withdrawals from the RRIF could end up pushing you into a higher tax bracket.

The bottom line: You can save thousands of dollars in OAS payments—and possibly income tax—with a savvy RRSP withdrawal strategy.

More tax tips here.

2 comments on “The tax tip all retirees should know

  1. how do I find out how to create a smart RRSP withdrawal strategy?

    Reply

    • There is no simple answer to your question, because there are many factors that come into play. These can include your age, your life expectancy, the amount of your RSP/RIF savings with its growth rate, all your sources of income from OAS, CPP, GIS, and investment income from your TFSA and “open” accounts. You also need to know the various levels of income that trigger claw backs and additional taxes. Then you try to keep your annual income below one of those thresholds that is most realistic to your situation.

      Keep in mind that your withdrawal strategy fails (and the Government wins) when you die prematurely, because the value of all your untaxed investments in your RSP/RIF and “open” accounts are deemed to be liquidated and added to your income on the year of your death. That can give you the highest income level ever, resulting in a 50% tax bite (or higher) on whatever untaxed money you left on the table upon your death.

      The goal of your withdrawal strategy is to transfer as much of your RSP/RIF portfolio to your “open” and TFSA accounts in annual increments that are large enough to outpace the growth rate of your RSP/RIF investments, but small enough to keep you annual income below the next highest tax threshold that will ding you with extra tax.

      As anexample, assume you are 65 years old with a RSP/RIF worth $300,000 growing at 5% annually ($15,000) while collecting $12,000 in CPP/OAS and $8000/year from your other investments in your “open” account. This means that your income stream breaks even at $35,000, whereby you never run out of money, but you leave your original $300,000 on the table to be taxed at over 50% when you die.

      The idea is to gradually shrink that $300,000 by transferring it to your TFSA and “Open” accounts without triggering any OAS claw backs or extra taxes from higher tax rates. Your withdrawal strategy is most successful when the value of your RSP/RIF portfolio nears zero upon death. All that means is that most of your RSP/FIF money now resides in your “open” and TFSA accounts having much less tax liability owed to the Government.

      With a life expectancy of another 20 years, you should withdraw at least $30,000 annually (300,000/20 + 15,000 growth) from your RIF/RSP. So you should target for an annual income of $50,000 (15,000 above the $35,000 breakeven mentioned above)..

      You may want to better optimise your RSP withdrawal each year based on the tax thresholds (of 2016) that near your $50,000 income level. So the portion of your income that exceeds:
      1) $41,536 will be taxed in Ontario at 9.15% instead of 5.05%.
      2) $45,282 will be taxed federally at 21.5% instead of 15%.

      So if your circumstances allow you, to reduce your income from $50,000 to $45,282 (perhaps your RSP investments had no growth in 2016), you will protect $4,718 from being taxed at the 21.5% threshold (which entails an extra $307 in tax from the 15% tax rate).

      I hope this provided you with sufficient insight to get started.

      Reply

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