How do I keep away from Previous Age Safety clawbacks resulting from excessive dividends?

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By Julie Cazzin with Allan Norman

Q: My spouse and I are 83 and 80, respectively, and I’m shedding my Previous Age Safety (OAS) resulting from dividends and my registered retirement earnings fund (RRIF) withdrawals. I want after I was youthful that somebody had informed me dividends may very well be an issue as a retiree. I’m pondering of cashing out my RRIF this yr and cashing in my shares for index funds so I can gather my OAS pension. Does this make sense? Our tax-free financial savings accounts (TFSAs) are maximized, I’ve $600,000 in RRIFs in addition to a pension of $45,000 per yr, and my spouse has $490,000 in a RIFF. Now we have non-registered investments of about $3.5 million with a dividend yield of about 3.2 per cent, and a small rental in my spouse’s identify with an earnings of $9,000 per yr. — Tim

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FP Solutions: You might be in a great spot, Tim, and it’s sensible to consider how you can reduce your taxable earnings to scale back OAS clawbacks, which apply in case your web earnings exceeds $90,997 in 2024. And you’ll have to repay 15 per cent of the surplus over this quantity to a most of the entire quantity of OAS obtained. Simply watch out that you simply don’t do one thing that may price you extra money in the long term.

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Don’t beat your self up about dividend investing. If, whenever you have been younger, you have been suggested that future dividends might end in OAS clawbacks, you might not have the cash you have got at the moment. Dividend investing is a relatively straightforward inventory choice technique, making it in style with DIY buyers. That, plus the truth that worth shares — usually dividend payers — have traditionally outperformed progress shares.

As we speak, your shares are producing a gentle movement of taxable dividends that you’re reporting in your tax return. Nonetheless, it’s essential to report the grossed-up (38 per cent) dividends, not the precise quantity of dividends obtained. For instance, when you obtain $100,000 in dividends, you report $138,000, which is the quantity used to evaluate OAS clawbacks. After the clawback evaluation, the dividend tax credit score is utilized, bringing down your taxable earnings.

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Dividends are one tax situation in a non-registered account. Capital good points, that are the distinction between the e-book and market worth of an asset similar to shares or funding actual property, are the opposite tax situation, and they’ll additionally influence your OAS eligibility.

The problem with holding particular person shares in a non-registered account is the tax drag (the discount in potential earnings or progress resulting from taxes on funding good points) created by dividends and capital good points when buying and selling shares.

My guess is you might be pondering of switching to index funds as a result of they are typically extra tax environment friendly, are longer-term holds and, in line with the SPIVA stories — which evaluate returns from energetic fairness and fixed-income mutual funds and their benchmarks — usually tend to outperform managed portfolios.

In relation to RRIFs, I usually counsel to individuals beginning retirement not to attract greater than wanted until the surplus goes into one other tax shelter similar to a TFSA. The rationale for that is due to the tax drag I described above.

In case you draw extra cash out of your RRIF, you pay tax and have much less cash to reinvest. In your case, Tim, that quantities to about 40 per cent much less or much more, relying on the quantity you draw out of your RRIF. You might be additionally topic to the tax drag of dividends and capital good points whenever you spend money on a non-registered account.

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Having mentioned that, as you draw nearer to the tip of your life, there’s a tipping level when it begins to make sense to attract out of your RRIF and spend money on a non-registered account. Within the yr of your dying, your marginal tax price (in Ontario) shall be 53.53 per cent. In case you can draw cash out of your RRIF at a decrease tax price within the yr previous to your dying, that’s higher than leaving all of it to the tip when it’s taxed at the next price.

Identical to the youthful retiree withdrawing extra from their RRIF, you might be nonetheless confronted with much less cash to speculate and a tax drag. The distinction, utilizing the instance above, is that there’s just one yr of the tax drag, and when you had left the cash within the RRIF, just one yr for the tax-deferred progress to make up for the bigger tax price within the closing yr.

I used to be curious to see what would occur when you withdrew all of your RRIF cash now at age 83, or sufficient every year to deplete it by age 90, in comparison with leaving all of it till age 90. I discovered that in each circumstances, utilizing age 83 as your tipping level, you might be higher off not withdrawing extra cash out of your RRIF.

There’s, nonetheless, a bonus when you withdraw cash out of your RRIF and present it to your kids. I discovered the most important acquire, as measured by the entire wealth switch to your kids, got here whenever you withdrew every part out of your RRIF in a single shot quite than depleting it over seven years. After all, the entire acquire will rely on what and the way your kids make investments the cash.

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Have you considered charitable contributions? Together with extra RRIF withdrawals, or by itself, you can donate a few of your shares with massive capital good points to a charity. By doing this, you keep away from the capital good points tax, thereby supplying you with extra money to speculate and a bigger charitable tax credit score.

Tim, with the belongings you have got, I don’t see you escaping the OAS clawback until you maybe withdraw every part out of your RRIF now and donate all of your non-registered investments to a charity. If it makes you are feeling any higher, it’s the after-tax OAS quantity you aren’t receiving.

Allan Norman, M.Sc., CFP, CIM, gives fee-only licensed monetary planning companies and insurance coverage merchandise via Atlantis Monetary Inc. and gives funding advisory companies via Aligned Capital Companions Inc., which is regulated by the Canadian Funding Regulatory Group. Allan could be reached at alnorman@atlantisfinancial.ca.

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