Seniors and Investors – Watch Clawback Zones Carefully

It’s reasonably common knowledge that higher wealth accumulators in Canada will want to do some extra planning to avoid the 33% high federal income tax rate applicable to the terminal return of the last surviving spouse.  

This is generally accomplished by averaging in their taxable pension amounts throughout retirement, if possible.

However, a sharp eye on marginal tax rates is important in this activity, because clawbacks of the Age Amount and Old Age Security can make income averaging opportunities precipitous.

In fact, when you ask the question, who pays the highest marginal tax rates in Canada, you might be surprised to know it’s not those whose income exceeds $200,000.  The answer depends on the type of income sources.  But it also depends on whether the taxpayer is subject to a clawback of social benefits and credits. 

Let’s see how clawbacks affect seniors and investors in 2016 under various scenarios.

In the first, seniors are subject to clawbacks of the age amount, the GST/HST Credit and the Old Age Security at various income levels.  (We have looked at incomes over $30,000 which ignores those who qualify for the Guaranteed Income Supplement  (GIC), which is clawed back at rates of 50% as income rises)

Scenario: Ontario senior couple, one with eligible pension income spouse has no income.

Clawbacks of social benefits and credits occur as income rise.  Red ranges in the table are subject to clawback of the Age Amount.  Highlighted income ranges are subject to clawback of OAS.

A typical relief is to reduce net income with an RRSP contribution, if the taxpayer is age eligible and if there is contribution room. 

That’s important.  Given the prohibitive marginal tax rates, RRSP contribution opportunities form part of the overall retirement income planning pre-retirees do.  So do subsequent re-investments of after-tax remainders into Tax Free Savings Accounts.

But remember, what goes into an RRSP must come back out.  Once the taxpayer is in the OAS clawback zone, deferrals using RRSP contributions will only be of benefit if the taxpayer will not be in that same clawback zone when they are required to withdraw from their RRIF.

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