Make the most of your retirement income sources

Government benefits provide a slim base; maximize their impact by cutting back on clawbacks.

Matthew Elder 28 January, 2015 | 6:00PM

Note: This article is part of Morningstar's January 2015 RRSP Check-up special report.

Canada's social safety net provides income during retirement through Old Age Security, the Guaranteed Income Supplement and the Canada or Quebec Pension Plan. Those over age 65 also get a tax break in the form of the age tax credit, which is worth about $1,000 for lower-income taxpayers.

However, even with maximum benefits from these government programs, it isn't enough to get by on. Moreover, except for CPP/QPP income, middle and high income taxpayers lose most or all of these benefits through income-tested clawbacks.

Indeed, the GIS is available only to persons with net income of about $17,000 or less, while the OAS starts to be "clawed back" on incomes of about $71,000. The age credit also is hit by a clawback for those with net incomes of about $35,000 or higher. Even without clawbacks, at current levels the most an individual can receive from OAS and CPP/QPP is less than $20,000 a year.

There are a number of ways to reduce or avoid clawbacks. Chief among them is splitting your pension income with your spouse or common-law partner. You are allowed to give up to 50% of your income from a registered pension plan, registered retirement income fund (RRIF) or registered annuity to your spouse or partner. This helps create two streams of income that might fully or partially avoid clawbacks.

Note that clawbacks can be triggered if you have capital gains to report on your tax return, because net income is calculated before capital gains are offset by any capital losses you might have carried forward from a previous taxation year.

An effective way to avoid triggering capital gains from the sale of equity investments is to invest through corporate-class mutual funds. These funds allow you to switch your money from one asset class to another without triggering capital gains.

Here's a brief overview of the sources of income a typical Canadian can receive during retirement, and how they can be affected by clawbacks or income tax:

Age tax credit: This is worth up to $1,037 (15% of the $6,816 overall amount stated on the income-tax return) for 2014. It's a non-refundable amount, which means you must have at least that amount of net income to be able to claim it fully. The credit is subject to a clawback if your net income is $34,873 or higher, and is eliminated once net income reaches $80,980. For example, at a net income of $50,000, this credit is reduced to $697, and at $65,000, to $360.

OAS: You can begin receiving this benefit at age 65, or opt to delay beginning to receive it until as late as 70. OAS, which is taxable income, currently pays $563.74 a month at age 65. The OAS clawback (or "recovery tax" as the Canada Revenue Agency calls it) kicks in when your net income exceeds $70,954. Your OAS benefit is completely clawed back once your income exceeds $114,815. The clawback amount is deducted from your monthly OAS payments.

The income amounts used to determine the OAS clawback are based on net income two years ago for payments made during the first six months of the year, and on last year's net income for payments made during the last six months.

During 2015, then, 2013 net income will be used to compute the clawback of OAS received between January and June, while 2014 net income will apply to the clawback on for the July-December period.

Assuming a net income amount of $80,000, the annual OAS benefit would be reduced from the maximum $6,765 to $5,357, while at $100,000, it would be just $2,357. The clawback income range is adjusted every three months, based on changes in the Consumer Price Index. In some cases it may be worth opting to delay beginning to receive OAS for up to five years. Introduced with the 2012 federal budget, the voluntary deferral of the OAS pension allows individuals to receive higher benefits to the tune of 0.6% per month of deferral. For someone who chooses to wait the full five years before receiving their initial payment, this would work out to a 36% premium.

GIS: This is available to low-income individuals and couples, and is as much as $9,173 a year for an individual who received the full OAS, and $6,082 per person if both spouses receive full OAS benefits. GIS income is tax-free.

CPP/QPP: The maximum monthly payment during 2015 is $1,065, or $12,780 annually, for someone who starts taking income at age 65 and who no longer contributes to the plan. The amount you are entitled to receive depends on how much and over how many years you contributed to the plan, and the age at which you begin taking income. CPP/QPP benefits are taxable, but there's no clawback, regardless of your income level.

Registered plans: Income received from a registered pension plan, RRIF or life-income fund (LIF) is fully taxable at your marginal tax rate. This is because the amounts you contributed to these accounts were tax-deductible -- the RRIF being the extension of an RRSP and the LIF the product of a locked-in retirement account, or LIRA. A LIRA is a registered account into which proceeds of a registered pension plan can be transferred when you leave an employer before retirement. You can withdraw from LIRA assets only through a LIF, according to a prescribed formula that limits the annual withdrawal amounts.

Tax-free savings account (TFSA): Any income earned within a TFSA, for which the maximum annual contribution is currently $5,500, is not taxable. Nor do withdrawals add to your net income. This makes the TFSA another effective anti-clawback tool for financial planning.

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Matthew Elder

Matthew Elder