It often comes without warning from the murky depths of the Canada Revenue Agency: It’s the claw. And for investors who don’t plan ahead there’s nowhere to hide.
Retirees who hold too much in their registered retirement savings plans (RRSP) could be backed into a tax corner and even have their Old Age Security (OAS) benefits clawed back by the government.
All RRSP withdrawals are fully taxed. If the withdrawals are large, they are taxed in a higher bracket. When the plan holder turns 70 the RRSP must be converted to a registered retirement income fund (RRIF) where minimum withdrawals are required based on the total amount in the plan, your age and the age of your spouse. As of 2018, any withdrawals over $75,910 will trigger an OAS clawback of about 15 per cent.
There are four ways to avoid the OAS clawback, or having RRIF withdrawals taxed in a high income bracket:
- Income can be split between a higher-income spouse and lower-income spouse after 65 to keep as much money in lower tax brackets as possible. It can also be split well before retirement if the higher-income spouse contributes to a spousal RRSP. The contribution goes to the lower-income spouse, but the tax break goes to the higher income spouse.
- Contribute more to your tax free savings account (TFSA) during your saving years. Withdrawals in retirement are not taxed and can be a perfect top-up to RRIF withdrawals in a lower tax bracket.
- Capital gains from the sale of a principal residence are not taxed, much like a TFSA. That cash can be used as tax-free income if the homeowners downsize or move to rental accommodations.
- Borrowing from a home equity line of credit (HELOC) or a reverse mortgage can also provide tax-free income but it’s important to keep in mind interest accumulation could drain overall savings.