Although most financial investments carry some degree of risk, investors can, with forethought, control much of that risk. One of the greatest investment oversights is lack of focus on minimizing taxes on investment portfolios — often resulting in unnecessarily high income taxes. A major example is the tax obligation incurred through the partial or total claw-back of OAS benefits.
While still in the accumulation phase, the tax-exempt nature of RRSPs allows investors to be unconcerned about tax consequences. However, longer-range tax planning, even for RRSP accounts, is in order.
All RRSP accounts must eventually be converted to Registered Retirement Income Funds (RRIFs) by age 71; draws on the RRIFs must commence no later than age 72. Well before the draws commence, the investor needs to project what the mandatory 7.48 per cent withdrawal (at age 72) will mean to his total annual income. Should the total income be projected to exceed $71,000, the Old Age Security entitlement will be subject to claw-back. At roughly $115,000 annual income, the full OAS benefit, currently about $6,550, would be totally clawed back. Both the minimum and maximum thresholds are adjusted annually for inflation.
Through careful planning — even prior to retirement — full OAS benefits might be preserved. If, even after allowable pension-splitting is considered, an investor’s RRSP is projected to eventually threaten the OAS benefit, the holder may opt to convert his RRSP to a RRIF, and commence earlier withdrawals from the plan. The intent would be to draw sufficient funds from the RRIF to ensure the total annual income remains below the minimum $71,000 at which claw-back begins to erode the OAS benefit.
Another option for the investor is to begin contributing less to RRSPs and instead, fully maximize his/her Tax-Free Savings Account (TFSA) eligibility. Neither future income nor capital drawn from TFSAs is considered as income for tax purposes. Hence, OAS eligibility remains intact.
The OAS benefit is of great value to the average retiree. If a retiree were for example, to receive the full $6,550 annual payment for 25 years, indexed at two per cent annually for inflation, he/she would need approximately $120,000 of extra capital, invested at a five per cent annual return, to match it. The potential loss of this guaranteed long-term benefit with such significant capital value is clearly worth protecting. Advance planning, well before retirement, may preserve the full OAS value in retirement.
Some of you may say, great advice, but it’s too late — you are now retired and already subject to an OAS claw-back. Consult with your accountant to determine if it might make sense to make one large RRIF withdrawal, with its obvious tax consequence, so that future years’ income levels are kept below the claw-back threshold.
In short, it is neither too early, nor too late, to utilize tax planning as a key to enhancing retirement income.
A retired corporate executive, enjoying post-retirement as an independent financial consultant, Peter Dolezal is the author of three books.