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 Old Age Security 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 threshold ($79,054 for 2020), you’ll have to repay part or all of your Old Age Security benefits for that year.

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 $13,000 in dividends may think they come in under the limit, but are actually pushed over it by the gross-up.

The clawback is 15% of the amount by which your income exceeds the threshold. Put differently, your Old Age Security will drop by 15 cents for every dollar your net income exceeds the threshold. If your income is high enough, it will result in clawback that brings your Old Age Security benefit to $0.

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 accounts in which they’re held.

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 Old Age Security clawback, your taxes payable will still be higher than with dividends.

Reducing clawback with a T-SWP

Most mutual fund companies offer T-SWP (Tax-Efficient Systematic Withdrawal Plan) series of their products, which 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 Old Age Security clawback rules 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 clawback, 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 Old Age Security clawback rules, albeit in a more controlled fashion if anticipated and properly planned for.

Let us help

Reducing your taxable income and avoiding the Old Age Security 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.

This article is a general discussion of certain issues intended as general information only and should not be relied upon as tax or legal advice. Please obtain independent professional advice, in the context of your particular circumstances. iA Private Wealth is a trademark and business name under which iA Private Wealth Inc. operates. iA Private Wealth Inc. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada.

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iA Private Wealth Inc. is a member of the Canadian Investor Protection Fund and the Canadian Investment Regulatory Organization. iA Private Wealth is a trademark and a business name under which iA Private Wealth Inc. operates.

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