How do I avoid Old Age Security clawbacks due to high dividends?

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By Julie Cazzin with Allan Norman

Q: My spouse and I are 83 and 80, respectively, and I’m shedding my Old Age Security (OAS) as a consequence of dividends and my registered retirement income fund (RRIF) withdrawals. I want once I was youthful that somebody had informed me dividends could possibly be an issue as a retiree. I’m considering of cashing out my RRIF this 12 months and cashing in my shares for index funds so I can acquire my OAS pension. Does this make sense? Our tax-free savings accounts (TFSAs) are maximized, I’ve $600,000 in RRIFs in addition to a pension of $45,000 per 12 months, and my spouse has $490,000 in a RIFF. We now have non-registered investments of about $3.5 million with a dividend yield of about 3.2 per cent, and a small rental in my spouse’s title with an revenue of $9,000 per 12 months. — Tim

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FP Solutions: You might be in a great spot, Tim, and it’s sensible to consider methods to reduce your taxable revenue to cut back OAS clawbacks, which apply in case your web revenue exceeds $90,997 in 2024. And you’ll have to repay 15 per cent of the surplus over this quantity to a most of the full quantity of OAS obtained. Simply watch out that you just don’t do one thing that may value you more cash in the long term.

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Don’t beat your self up about dividend investing. If, once you have been younger, you have been suggested that future dividends might end in OAS clawbacks, you could not have the cash you’ve at present. Dividend investing is a relatively straightforward inventory choice technique, making it widespread with DIY traders. That, plus the truth that worth shares — usually dividend payers — have traditionally outperformed progress shares.

In the present day, your shares are producing a gentle circulate of taxable dividends that you’re reporting in your tax return. Nevertheless, you need to report the grossed-up (38 per cent) dividends, not the precise quantity of dividends obtained. For instance, in case you obtain $100,000 in dividends, you report $138,000, which is the quantity used to evaluate OAS clawbacks. After the clawback evaluation, the dividend tax credit score is utilized, bringing down your taxable revenue.

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Dividends are one tax challenge in a non-registered account. Capital features, that are the distinction between the ebook and market worth of an asset corresponding to shares or funding actual property, are the opposite tax challenge, and they’re going to additionally influence your OAS eligibility.

The problem with holding particular person shares in a non-registered account is the tax drag (the discount in potential revenue or progress as a consequence of taxes on funding features) created by dividends and capital features when buying and selling shares.

My guess is you’re considering of switching to index funds as a result of they are typically extra tax environment friendly, are longer-term holds and, in accordance with the SPIVA stories — which examine returns from lively fairness and fixed-income mutual funds and their benchmarks — usually tend to outperform managed portfolios.

On the subject of RRIFs, I usually recommend to individuals beginning retirement not to attract greater than wanted until the surplus goes into one other tax shelter corresponding to a TFSA. The rationale for that is due to the tax drag I described above.

Should you draw extra cash out of your RRIF, you pay tax and have much less cash to reinvest. In your case, Tim, that quantities to about 40 per cent much less or much more, relying on the quantity you draw out of your RRIF. You might be additionally topic to the tax drag of dividends and capital features once you put money into a non-registered account.

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Having mentioned that, as you draw nearer to the top of your life, there’s a tipping level when it begins to make sense to attract out of your RRIF and put money into a non-registered account. Within the 12 months of your loss of life, your marginal tax charge (in Ontario) will likely be 53.53 per cent. Should you can draw cash out of your RRIF at a decrease tax charge within the 12 months previous to your loss of life, that’s higher than leaving all of it to the top when it’s taxed at the next charge.

Similar to the youthful retiree withdrawing extra from their RRIF, you’re nonetheless confronted with much less cash to take a position and a tax drag. The distinction, utilizing the instance above, is that there’s just one 12 months of the tax drag, and in case you had left the cash within the RRIF, just one 12 months for the tax-deferred progress to make up for the bigger tax charge within the closing 12 months.

I used to be curious to see what would occur in case you withdrew all of your RRIF cash now at age 83, or sufficient every year to deplete it by age 90, in comparison with leaving all of it till age 90. I discovered that in each instances, utilizing age 83 as your tipping level, you’re higher off not withdrawing extra cash out of your RRIF.

There’s, nonetheless, a bonus in case you withdraw cash out of your RRIF and reward it to your kids. I discovered the largest acquire, as measured by the full wealth switch to your kids, got here once you withdrew every part out of your RRIF in a single shot relatively than depleting it over seven years. In fact, the full acquire will rely upon what and the way your kids make investments the cash.

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Have you considered charitable contributions? Together with extra RRIF withdrawals, or by itself, you can donate a few of your shares with massive capital features to a charity. By doing this, you keep away from the capital features tax, thereby providing you with more cash to take a position and a bigger charitable tax credit score.

Tim, with the belongings you’ve, I don’t see you escaping the OAS clawback until you maybe withdraw every part out of your RRIF now and donate all of your non-registered investments to a charity. If it makes you’re feeling any higher, it’s the after-tax OAS quantity you aren’t receiving.

Allan Norman, M.Sc., CFP, CIM, gives fee-only licensed monetary planning companies and insurance coverage merchandise via Atlantis Monetary Inc. and gives funding advisory companies via Aligned Capital Companions Inc., which is regulated by the Canadian Investment Regulatory Organization. Allan might be reached at alnorman@atlantisfinancial.ca.

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