Q: My husband and I are retired and turning 63 and 60 this year. We have combined RRSPs of $220,000 that are not needed to cover our regular expenses. Our pensions and rental income will put us slightly over the OAS clawback threshold when we are both 65. We want to minimize the tax hit on our RRSPs and so I have run various scenarios with the aid of the calculators.
First I calculated the tax as if we withdrew no RRSPs and transferred pension income to minimize overall tax. Then I added a whopping $57,000 in RRSP withdrawals so that we both would report income of just below $106,543 (2016 marginal tax rates). Then I calculated our tax without RRSPs when we are both 65 plus and then added just $10k each in RRSP income.
Should I plan to deplete our RRSPs and delay my husband’s OAS by one year to fully collapse our plans? My calculations suggest we could save over $12,000 in taxes this way.
A: The Old Age Security (OAS) clawback can be painful for some seniors—especially those with Defined Benefit pension plans and high incomes. If your net income on line 236 of your tax return exceeded $72,809 on your recent 2015 income tax filing, your OAS pension for the July 2016 to June 2017 payment period will be reduced by 15 cents for every dollar in excess.
Given that tax rates range from 28% to 38% at $73,000 of income depending on your province of residence, seniors subject to OAS clawback end up paying an effective rate of tax of between 43% and 53% at least once their income hits this level.
Your problem, Patricia, is a good one to have. You and your husband have high incomes and you admit that you don’t really need your RRSPs to fund your retirement lifestyle. It still makes sense to try to maximize your income and keep more of your after-tax earnings and I’ll try to help you.
You do have a few simple options available. If you haven’t already begun your Canada Pension Plan (CPP) retirement pensions, you can delay CPP as late as age 70. This could help keep your incomes lower for the next 7-10 years until your respective ages of 70.
OAS can also be delayed as late as age 70, enabling you to whittle away at your RRSPs, Patricia.
With both CPP and OAS, delaying your pensions results in higher future payments, albeit for fewer years.
That said, how much tax you might pay or save in the next few years needs to be compared to what you might save or pay over the next 20. Financial planners—not the kind that sell mutual funds, the ones that actually plan finances—can help you model various retirement income scenarios in order to try to determine the most optimal drawdown options. They use sophisticated software to try to consider all the factors in building an objective financial plan.
It may very well be that withdrawing from your RRSPs before you need to at age 72 and delaying CPP and OAS can increase your retirement incomes and more importantly over time, your net worth.
Beyond the obvious RRSP, CPP and OAS timing options, Patricia, you have to contend with your rental properties. Rental income is often like an indexed pension, rising annually over time. This can be good for cash flow, but bad for taxes.
Are you claiming depreciation on your rental properties? Capital cost allowance or CCA can be claimed on your tax returns to depreciate your rental properties and reduce your taxable rental income. Depreciation can be claimed at a rate of 4% on most rental properties and can be deducted up to the point where your rental income is zero. It cannot be used to create or increase a rental loss.
I am working with a client in a similar situation to yours, Patricia. In their case, we have actually opted to set up a corporation to hold their rental properties. They are transferring their properties to the corporation on a tax-free basis to earn the rental income in the corporation—in part, to reduce their OAS clawback. They provide support for two adult children, one of whom has a medical condition that prevents her from working. The corporation will allow them to pay dividend income to their children and pay less overall tax as a family than if they earned the rental income personally and supported their kids financially.
Strategies like this can be of particular interest in a case like yours since it sounds like you may have more than what you need financially to sustain yourselves for the rest of your lives. My clients with the rental properties are in the same situation and contemplating an estate freeze with their incorporated rental real estate as a means of passing the future capital gains on their real estate to their kids, to stop the clock on that ticking tax time bomb.
A financial plan can help younger people plan for retirement and older people to fund it in the most efficient way. Sometimes, a little creativity can make a massive difference in terms of your lifetime tax payable, government benefits entitlement, retirement income options and the estate that you leave to your beneficiaries.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.