I’ve said it before and I’ll say it again – even in the simplest of situations, there almost always seems to be a way to save or defer more personal income tax.
What’s a perfect example? Seniors.
Seniors are typically people who are retired or have relatively simple tax situations. Even in their circumstances, there are lots of opportunities to improve their financial affairs.
Seniors can save a lot of taxes with proper planning.
‘Tax Tips for Seniors’ is going to be split up into two parts. In the first part, I’ll discuss income. In the second part, I’ll discuss expenses and credits. Let’s jump right into it…
Old Age Security (OAS)
Everybody’s heard of OAS. But it’s important to know some of the specifics.
OAS is a payment available to Canadian citizens age 65 or older who have lived in Canada for at least 10 years since age 18. It’s also available to Canadians living outside Canada who were citizens or legal residents at any time they left the country, so long as they lived in Canada for at least 20 years after age 18.
A lot of people aren’t aware of the fact that you must actually apply to receive the payments. That means that you will not automatically begin receiving OAS just by filing your personal tax returns as is the case with some other government funding. So, my recommendation is that you be aware of this fact and be proactive by applying for OAS before you’re eligible to receive it. This will allow you to avoid any potential delays in receiving your payments.
It’s also important to know that, depending on your income level, the OAS you’re entitled to receive may be ‘clawed-back’ (see below). This claw-back can partially or entirely eliminate your OAS payments. However, there’s a way to avoid this as I’ll discuss in a moment.
Know the rules relating to OAS and plan accordingly to maximize your payments.
Most individuals simply apply and begin receiving OAS once they’re entitled to it at age 65. However, a rather unknown fact is that you’re actually able to voluntarily defer receipt of OAS payments for up to five years. This can be extremely advantageous depending on your particular situation. Why would anyone want to do this? Well, doing so entitles you to receive a higher, actuarial adjusted, pension in the future. The current adjustment rate is set at an increase of 0.60% per month. This means that you can receive an increase of up to 36% if you defer it until the time you’re age 70.
So, who might want to defer their OAS payments? This should definitely be considered by those who don’t need to receive OAS right away beginning at age 65. More specifically, if you can afford to defer it, consider doing so. People who earn more than the annual income threshold which triggers the start of the OAS claw-back (see below) may want to defer receiving it. Again, if they don’t, then they risk having to repay it partially or entirely. A simplified strategy is to defer it until a time when you receive less income and are able to keep all or most of your OAS. At this time, your monthly payments would be higher because of the increase for every month it’s deferred.
Consider deferring OAS now to increase your payments later.
OAS claw-back avoidance
For the 2014 taxation year, if your net income before adjustments is greater than approximately $72,000 then you will be required to repay 15% of the excess, up to the maximum OAS that you’re entitled to receive. The threshold range is indexed each year, but, for the 2014 taxation year, once your net income before adjustments reaches approximately $117,000 then your OAS will be entirely clawed-back (i.e., you will receive no OAS). If you’re able to manage your income then you’re in a position whereby you can control how much OAS you receive.
An important fact worth noting is that capital gains can increase your OAS claw-back regardless of whether you have capital losses to carry-forward. Some people think that, because they have the balance to carry-forward, they can use the capital losses from previous years to apply against a current year’s capital gain and, as a result, their income will not be affected for calculating the OAS claw-back. However, that is not true. Since the claw-back calculation is based on net income before adjustments, and capital losses carried forward are deducted after this amount, realized capital gains do in fact negatively affect your income for the purposes of calculating the OAS claw-back.
That’s a lot of information. However, it’s all very important. Now, how can you work around these issues? Answer these questions:
1. Are you approaching age 65?
2. Do you have significant unrealized capital gains?
3. Do you have a capital loss carry-forward balance?
4. Do you have enough income that realizing a capital gain would cause OAS claw-back?
If you answered ‘yes’ to these questions, then you may want to consider disposing of some of your investments now in order to realize the capital gains prior to applying for OAS. This would, of course, help avoid OAS claw-back when done properly.
You should also consider the type of income you’re reporting on your personal tax return. You need to remember that the amount of Canadian eligible dividends included in income is 138% of the actual amount received. This artificially increases your income for tax purposes and is another factor that negatively affects your income with respect to calculating the OAS claw-back. If you replace it with, say, interest income, your income would be lower but taxes payable higher even when OAS claw-back is included in your balance owing. This is because of the tax credits available related to Canadian eligible dividend income. In summary, don’t avoid investing in Canadian eligible dividend income generating investments because of the OAS claw-back – they’re taxed more favourably than most sources of income.
Proactive and appropriate tax planning can ensure you receive all of your entitled OAS payments and allow you to avoid OAS claw-back.
Guaranteed Income Supplement (GIS)
GIS is a payment available to lower income seniors receiving OAS or eligible to receive OAS. Similarly to OAS, it is not automatically received when you file your personal tax return. Again, an application must be filed. However, an attractive feature of GIS is that it’s not taxable income.
What’s GIS worth? As of 2014, the maximum combined payment from OAS plus GIS is $1,299 ($551 OAS + $747 GIS).
But of course, not everyone is entitled to receive it. Your entitlement is dependent on your marital status and income in the prior year. For the 2014 taxation year, you would be eligible if you’re:
1. Single and your income is less than approximately $17,000;
2. Married or common-law, both are OAS pensioners and combined income is less than approximately $22,000; or
3. An OAS pensioner whose spouse or common-law partner is not receiving OAS and your combined income is less than approximately $40,000
Don’t miss out on applying for and receiving GIS.
As of 2007, Canadian residents have the option to split certain pension income with their resident spouse or common-law partner. Pension splitting, when done properly, can save thousands of tax dollars each year when done properly.
The rules are rather simple. Half of a taxpayer’s eligible pension income can be split and allocated to the other taxpayer. This may seem confusing at first. Note that no funds are actually transferred. Your taxable incomes are simply adjusted by allocating income from one taxpayer to the other when filing your personal tax returns. The essential part is to optimize the amount allocated and related tax withholdings. Doing this incorrectly may actually make things worse.
If it’s determined that you’ve missed out on a pension splitting opportunity, it’s not too late. Adjustments can be made to your personal tax returns, but it’s important to ensure combined taxes payable are reduced or else the exercise is pointless.
Here’s another, perhaps simplified, strategy for your consideration. If you don’t already have eligible pension income in the year you turn 65, you may want to create some by converting a portion of your RRSP to a RRIF to take advantage of pension income tax credit and pension splitting tax savings. Remember – lump-sum withdrawals from an RRSP are not income eligible for pension income splitting.
Pension splitting can save thousands of tax dollars each year when done properly.
As you probably know, RRSP’s don’t need to be converted to a RRIF until the holder reaches age 71. With respect to the timing of withdrawing your RRSP funds and considering OAS at the same time, you have at least a couple of options. They are:
Delay withdrawing RRSP’s until 71 when you convert your RRSP’s to a RRIF. This would allow you to potentially delay OAS claw-back until that time; and
Strategically take out your RRSP’s early over several years so that when you take out the minimum required amounts when converted to a RRIF, there will be less principal to draw from, thereby reducing or eliminating any OAS claw-back.
Of course, it’s not that simple. You must consider several factors, including your age, expected retirement date and lifestyle expenses, amount in your account and so on. But it’s definitely something that can be figured out and is well worth it when done properly.
These are some important factors to consider regarding income sources and tax planning for seniors. Perhaps equally important are expenses and credits which we will discuss in ‘Tax Tips for Seniors – Part 2‘.