Written by Andrew Walker at The Motley Fool Canada
Canadian retirees who receive Old Age Security (OAS) pensions have to keep a close eye on their annual earnings from taxable sources. Once net world income tops a certain level, the Canada Revenue Agency (CRA) implements a pension recovery tax on OAS payments. The hit is widely referred to as the OAS clawback.
Inflation is driving up the price of food, insurance, gas, and other essential living costs for seniors. Government pensions such as the Canada Pension Plan (CPP) and OAS are indexed to inflation. Defined benefit (DB) company pension payments are normally indexed as well, but many retirees still find their budgets getting tight at the end of each month, even if they have decent pension earnings.
The last thing seniors need right now is a reduction in their OAS due to their overall income being too high.
OAS clawback rules
The CRA hits high-income seniors with a 15% OAS clawback on net world income that is above a minimum threshold. In the 2023 income year, the number to watch is $86,912. The OAS pension recovery tax increases until the person hits the maximum income recovery threshold. That amount is $142,428 for people in the 65 to 74 age bracket. It is $147,979 for retirees who are 75 and older.
For example, a person with 2023 net world income of $116,912 would have their OAS reduced by $4,500 for the OAS payment period that runs from July 2024 to June 2025. That’s a big hit.
Income from a company pension, CPP, OAS, Registered Retirement Savings Plan withdrawals or mandatory payments from a Registered Retirement Income Fund are all taxable and included in the net world income calculation. Income from investments held in taxable accounts is also included.
One way to reduce net world income, or at least avoid driving it higher, is to make sure that Tax-Free Savings Account (TFSA) contributions are at their maximum level before holding investments in taxable accounts.
The TFSA limit is $6,500 in 2023. The government gives Canadians more TFSA contribution room each year and raises the annual limit size in increments of $500, indexed to inflation. TFSA contribution space that is unused in a particular year can be carried forward. The cumulative maximum TFSA contribution space is currently $88,000. Retirees can take advantage of the TFSA investment room to generate extra income on savings and reduce or avoid the OAS clawback.
All earnings generated inside a TFSA, including interest, dividends, and capital gains is tax-free and can go straight into your pocket. The CRA doesn’t include the profits in the net world income calculation.
Money removed from the TFSA during the year opens up equivalent new contribution room in the next calendar year on top of the regular boost in the TFSA limit.
TFSA investments for passive income
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Investors who prefer the safety of fixed-income investments can get rates above 5% on Guaranteed Investment Certificates today.
The bottom line on avoiding the OAS clawback
Holding investments inside a TFSA instead of in a taxable account is a good way to reduce net world income and avoid, or at least reduce, the amount of the OAS clawback.
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The Motley Fool recommends Enbridge and TELUS. The Motley Fool has a disclosure policy. Fool contributor Andrew Walker owns shares of Telus and Enbridge.