When the gross-up means a clawback: The impact of dividend income on Old Age Security

As a retiree, it’s important to understand how the eligible Canadian dividend income you may receive affects your Old Age Security (OAS) – and whether to do anything about it. Here’s what you need to know to make an informed decision about managing this aspect of your retirement income.

Eligible Canadian dividends and your taxes

Remember that for the purposes of your tax return, you’re required to gross-up your Canadian dividends by 38% and declare that amount as income. In other words, if you collect $100 in dividends, you report it as having received $138 in income. This gross-up normally doesn’t matter because the tax on dividends is still lower than on say, employment income. But if you’re a senior, be aware that the dividend gross-up can push you over the OAS clawback threshold.

From grossing up to giving up

In general, if your net income before adjustments (on line 234 of your tax return) exceeds a certain minimum threshold amount, you’ll have to repay all or part of your OAS benefits for that year. For 2019, OAS will start getting clawed back when your income is higher than $77,580.

If you’re not managing your income sources carefully enough, you could unintentionally compromise how much OAS you’re eligible for. For example, a senior who earns $65,000 from pensions and another $10,000 in dividends may think they come in under the limit, but are actually pushed over it by the gross-up.

The clawback is basically 15% of the amount by which your income exceeds the minimum threshold up until when your OAS is fully recovered. Said differently, your OAS will drop by 15 cents for every dollar your net income exceeds the $77,580 limit. For 2019, your OAS reduces to zero once your net income reaches $125,937.

Do you need to take action?

Besides dividends, interest and capital gains can serve as other sources of investment income. They’re all treated differently from a tax perspective and the type of plans in which they’re held: Open or registered.

If you’re looking to lower your income from taxable investments on line 234, strategies can include keeping eligible dividends in a Tax-Free Savings Account (TFSA), or focusing on generating capital gains, since only 50% are subject to tax. Because interest income is most highly taxed, there’s no advantage to replacing your dividend earners with interest-bearing investments – even with the OAS clawback, your taxes payable will still be higher than with dividends.

Helping to avoid the clawback – but not taxes – with a T-SWP

Some mutual fund companies offer T-SWP (Tax-Efficient Systematic Withdrawal Plan) series of their products that permit the withdrawal of capital before investment earnings. These “return of capital” (ROC) distributions reduce the adjusted cost base (ACB) of your investment for tax purposes. Because ROC is just your own money coming back to you, it isn’t considered taxable and OAS clawback rules also don’t apply. However, capital gains are eventually triggered when you sell your investment or when your ACB reaches zero.

While a T-SWP provides the advantage of helping to keep your taxable income low to avoid any clawbacks, you need to stay aware of your ACB and if, or when, it reaches zero. At that point, any withdrawals from a T-SWP would be fully taxable and subject to OAS clawback rules, albeit in a more controlled fashion if anticipated and properly planned for.

Let us help

Reducing your taxable income and avoiding the OAS clawback starts with understanding and assessing your retirement income sources. We can help you evaluate your tax situation while ensuring you don’t lose sight of the bigger picture about your finances, including your short- and long-term goals, risk tolerance and unique needs. Learn more about maximizing your retirement income by contacting us today.

 

iA Securities is a trademark and business name under which Industrial Alliance Securities Inc. operates. Industrial Alliance Securities Inc. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada.