My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a Chartered Professional Accountant and a partner with a National Accounting Firm in Toronto. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. The views and opinions expressed in this blog are written solely in my personal capacity and cannot be attributed to the accounting firm with which I am affiliated. My posts are blunt, opinionated and even have a twist of humor/sarcasm. You've been warned. Please note the blog posts are time sensitive and subject to changes in legislation or law.

Monday, December 1, 2014

Tax Planning Strategies to Minimize the Old Age Security Clawback

Question: How does an accountant enrage a sweet, mild mannered genteel grandmother?

Answer: Tell her some or all of her Old Age Security (“OAS”) payments were clawed-back on her tax return.

One lesson I have learned over the years is that whether a senior is a multi-millionaire or just well to do, they consider their OAS payment as sacred and any tax planning that causes even one dollar to be clawed-back may result in a tirade against their shell-shocked accountant.

I can only surmise that people feel they are entitled to so little in retirement related payments that they feel it is very unfair to have any of it taken away. I also think some people mistakenly think they have paid taxes to fund the Old Age Security program; however, that is a common misconception. The plan is funded out of the general revenues of the Government of Canada, which means that you do not directly pay into the OAS plan.

In any event, it is prudent for you and/or your accountant to plan to minimize any OAS clawback and that is my topic for today.

Old Age Security


The OAS is a monthly payment available to most Canadians 65 years of age (will gradually increase from 65 to 67 over six years, starting in April 2023). The eligibility requirements are here:

The maximum monthly OAS payment is currently $563.74 (October to December).

For 2014, you must reimburse all or part of your OAS pension if your net individual income exceeds $71,592 (including the OAS pension). The total amount of this reimbursement is equal to 15% of your net income (including the OAS pension) that exceeds $71,592. The full amount of OAS will be repaid when net income exceeds approximately $117,700.

Avoiding the Clawback


Split Income Election


For most people, the best income splitting technique available, and the most effective way to reduce your income, and thus reduce your OAS clawback, is to elect to split pension income (pension income includes most types of pension income, excluding OAS, CPP/QPP). The election is made by filing Form T1032, “Joint Election to Split Pension Income” with you and your spouse’s annual tax returns. CPP can be split also, but a request must be made to Service Canada (Pension sharing form ISP-1002A)

Income Sources


Not all income is treated equally. Only ½ of your capital gains are taxed, while interest income is fully taxable. Dividends are a strange animal as they are subject to a dividend gross-up (38% for public co. dividends) which causes your income to be increased. Thus, dividends can be detrimental for OAS planning purposes; however, the dividend tax credit tail should not solely wag the investment decision.

Holding Company


If you transfer your non-registered investments into a Holding Company (a rollover tax election form needs to be filed), you will no longer earn this income personally and you may reduce or eliminate your holdback. This sounds like a sexy solution, however it often comes with complications. First of all, you will most likely have to pay an accountant to prepare financial statements and tax returns, which will eat up around half your OAS savings. In addition, upon your death, or upon the death of your spouse if you leave your assets to them, you will have a deemed disposition of your Holding Company shares. That means your estate must pay tax on the value of your holding company at death. This may cause a double tax on death that can often only be alleviated by undertaking some complicated tax planning.

However, you may be able to plan around the double tax issue as discussed by Tim Cestnick in this article

To quickly paraphrase Tim’s plan; you transfer your investments into a Holdco and take back an interest free loan. Each year the Holdco declares a dividend to you equal to the full amount of the after-tax earnings of the company. It is important to note the dividend is payable, not actually paid. To cover your yearly cash requirements, you repay your interest free loan as required. Depending upon your financial situation and longevity, at some point the loan is paid off and the company then begins to actually pay the declared dividends, but this could be 15-20 years from now.

When you pass away, your heirs become the owners of the Holdco. The investments can then be distributed from the company in the form of the declared and unpaid dividends and may allow for some income tax savings. More importantly, the value of the company’s shares at the time of your death may have minimal value because the dividend liability owing by the company may be around the same value as the investment assets. This significantly reduces the double tax issue.

This planning is complicated and before you undertake Tim’s plan, you should consult your accountant to ensure the plan makes sense based on your personal circumstances.

A Holdco also is very effective if you have significant US assets, as the Holdco assets are not subject to US estate tax.

Finally, if you have a separate will for your Holdco (at least in Ontario) you can minimize your probate fees.

TFSA


If you have not maximized your TFSA, you should transfer non-registered money that is generating taxable income into your TFSA, to the extent of your unused contribution limit.

Alter Ego Trust


Alter Ego Trusts are special trusts that can only be created by individuals 65 or over. During the individuals lifetime they must be the only person entitled to receive the income of the trust and the individual creating the trust must be the only person entitled to receive the assets of the trust prior to the death of the individual. There is also a similar concept known as a “joint partner trust” with pretty much the same rules, for married or common law partners.

Where you have non-registered assets throwing off significant interest and dividend income that is causing an OAS clawback, it may make sense to transfer these assets to an Alter Ego Trust to reduce your clawback. Generally the transfer of these assets to the trust is tax-free.

However, since the income earned on these assets will be taxed at the highest marginal rate in the Alter Ego Trust, you have to consider whether the OAS clawback savings and other advantages (probate protection), outweigh any extra income tax costs (i.e.: is the extra tax payment a result of having all this income tax at the highest rate, less than the OAS you get to now keep by moving those assets into the trust).

I have outlined various strategies above that may be used to reduce your OAS clawback. However, I caution you; the complications and extra costs of some of these strategies need to be compared to the actual OAS savings they produce, as I have found that many clients over 65 want fewer complications in their life, not more. Consequently, you may face a tug of war between complicating your financial life or just accepting an OAS clawback.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

9 comments:

  1. Lately, there has been some talk about TFSA as a source for significant tax free income that does not affect GIS payments.

    Right now it's not a big issue but it could be in the future.

    ReplyDelete
    Replies
    1. Hi Anon

      If someone is getting GIS, then a OAS clawback should not be an issue. However, u r correct, as TFSAs grow, they will affect many financial aspects such as GIS.

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  2. Assume one sets up a holding company, transfers nonregistered investments into it and now has an interest free loan from the holding company in return. You can take money out of that company tax free, up to the value of the loan. So you may have some years now where OAS clawback will be less of an issue.

    However, the investment income that is being retained in the holding corporation is being taxed at the corporate rate, which is usually slightly higher than the top personal rate.

    By transferring your assets to the holding company, you have given up the the personal tax brackets, which have lower tax rates on investment income than the company does.

    Is the decreased OAS clawback greater than the effect of losing those lower personal tax brackets?



    ReplyDelete
    Replies
    1. Hi Anon

      Good question. It depends. The higher corporate rates give rise to RDTOH (refundable dividend tax on hand) that would be refunded based on future dividends. So there also could be a time value of money issue and you may decide to pay a large dividend one year to get back the RDTOH and thus have an OAS clawback in that year. The decision has multiple variables, that is why I always say speak to your accountant

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  3. How is income calculated for OAS applicants who are now U.S. residents filing jointly as married? For example, couple net income is $150k but $140 is earned by the non-OAS applying spouse. Is the income split, $75k per "individual" and considered in excess of the $71,592 minimum threshold? Thanks.

    ReplyDelete
    Replies
    1. Hi Anon

      I am not following, as if you are US residents, why are you filing in Canada? Anyways, for Cdn purposes, the OAS clawback is based on net income line 234 and which includes a reduction for any elected split pension income.

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  4. Thanks BBC. We file taxes in U.S. Jointly as married. Even though I earn significantly less than my spouse, do I have to declare 50% of our joint net income to determine if the OAS clawback will affect me.

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  5. Looked into both a joint ownership and an AET for a cottage property currently owned by my mother. I have 2 brothers and a sister, and we have all enjoyed the cottage when time permitted. I took care of a majority of the maintenance year after year. My father & mother wanted to sell me the cottage provided that I pay the capital gains.

    The plan wrt joint ownership would be for me to pay 50% of the capital gains, then the remaining on my mother's death. I was advised that it would be more pertinent to take full ownership rather than a joint ownership scenario at which point the estate (father has recently passed) would not be burdened with capital gains, utilities, maintenance, etc.

    What roll could probate play in all this?

    Great blog BTW.

    ReplyDelete
    Replies
    1. Hi Anon

      I am not a probate specialist, so all I can say is to the extent you dont have 100% ownership, there may be probate on the portion your mom owns, but I would check with your lawyer.

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