As Canada’s baby boomers settle into retirement, many are being caught off guard by their complex financial situations. Getting the most out of Old Age Security (OAS), which for 2015 pays a maximum of $6,780, is a key challenge their advisors need to grapple with.

Consider the following case study.

Edwin, age 65, is recently retired. He never envisioned a retirement without work; so, to supplement his income, he launched a consulting business that allows him to work part-time at his leisure. In his first year of retirement, Edwin’s income consisted of the following:

Net business income: $10,000

Registered pension income: $50,000

OAS/CPP pension benefits: $15,000

Canadian eligible dividends: $15,000

Edwin has some experience with investments and has a good understanding of Canada’s retirement income system. He’s aware OAS benefits are clawed back at a rate of 15% once net income reaches $72,809, and are eliminated completely at $117,954 (2015).

Given his $90,000 income for the year, Edwin thought his OAS benefit would be reduced by $2,579 for the year (or $215 a month), based on this calculation:

Net income ($10K + $50K + $15K + $15K) $90,000
Minus clawback threshold $72,809
Excess amount $17,191
Times clawback rate 15%
Clawback bite $2,578.65

When filing his tax return for the year, Edwin was surprised when his accountant pointed out his clawback was higher than he estimated. Instead of $2,579, it was $3,434, or approximately $70/month higher than he expected (or $286/month higher than a senior entitled to full benefits).

Why the difference?

Canadian dividends.

When calculating income for OAS purposes, Canadian dividends are grossed-up. So, instead of including the actual amount of dividends received in net income, the dividends are increased by a specified percentage.

For 2015, the gross-up is 38% for eligible dividends and 18% for non-eligible dividends. (Eligible dividends are typically received from publicly traded companies. Non-eligible dividends are usually paid by privately held companies from small business or investment income.) So, in Edwin’s case, his $15,000 of eligible dividends were grossed up to $20,700, with this amount being included in net income as follows:

Net income ($10K + $50K + $15K + $20,700) $95,700
Minus clawback threshold $72,809
Excess amount $22,891
Times clawback rate 15%
Clawback bite $3,433.65

The gross-up is part of the government’s attempt to ensure equal tax treatment for those who earn income through a corporation versus those who earn the same income personally. A dividend tax credit, which reduces tax payable on dividend income, is also part of this broader objective. But the credit applies after the calculation of OAS clawback, leaving many seniors with a smaller OAS benefit than they expected.

Read: A look at dividends and child support

Managing clawback

Here’s how to minimize clawback for clients.

Consider capital gains instead of dividends

Capital gains are not subject to a gross-up, and only 50% of capital gains are included in taxable income. So, investing for capital gains keeps net income to a minimum, preserving OAS benefits. Corporate class mutual funds can be an ideal vehicle: these funds are designed for capital appreciation, and tend to pay less in taxable distributions than certain stocks, bonds or mutual fund trusts each year. So, capital gains over time can be achieved tax-efficiently.

Should your clients require a regular income stream from their non-registered investments, a systematic withdrawal plan (which produces capital gain/loss treatment on the sale of investments) is a viable option.

Class-T mutual funds

Class-T mutual funds are tax-deferral vehicles. They allow clients to receive tax-efficient cash flow today, while deferring taxable income into the future. Many class-T funds provide clients with a cash flow distribution of up to 8% of the fund’s fair market value (FMV) annually, with the distribution being characterized as a tax-free return of capital (ROC). Because ROC distributions are not included in net income, OAS benefits are not impacted. Note, however, that ROC distributions do reduce the adjusted cost base (ACB) of the investment, creating capital gains tax on sale of the investment. Clients can, however, trigger the capital gain and associated tax liability whenever it suits them.

Minimize debt

By paying off debt or making major purchases before retirement, the need for income—and an increased exposure to an OAS clawback—is reduced.

RRSP contributions

Clients age 71 or younger should consider RRSP contributions. Many seniors have unused RRSP deduction room carried forward from previous years, or still have employment or self-employment income. RRSP contributions provide a deduction against income, reducing the base on which OAS clawbacks are calculated. For clients over 71, spousal contributions may be possible if the client has RRSP deduction room and a spouse or common-law partner (CLP) who is 71 or younger. Spousal contributions also provide income-splitting opportunities.

Read: Should clients use the lower RRIF withdrawals?

Income splitting

For couples, income splitting can preserve OAS benefits. Strategies include using spousal RRSPs, splitting eligible pension income, and sharing CPP or Quebec Pension Plan (QPP) benefits. For pension income splitting (where up to 50% of qualifying pensions can be split), eligible pension income includes payments from a registered pension plan, certain annuity payments, and, where a client is 65 or older, payments from a RRIF. For CPP/QPP purposes, benefits earned during the time of the relationship can be shared.

Spousal RRSPs and sharing CPP/QPP benefits require transferring cash from one spouse to the other, while splitting eligible pension income is a tax return transaction requiring no actual cash transfer.

Defer OAS and CPP/QPP pensions

As of July 2013, seniors were given the option to defer OAS pensions without penalty (up to 60 months). By deferring, seniors see an increase in their pensions of 7.2% for each year of deferral (or 0.6% per month). Similar options exist for CPP/QPP. Whether clients should defer depends on several factors, including life expectancy, cash flow needs and perception of the security of the programs (i.e., will they be there when needed?). Deferring pensions can help minimize or avoid clawback.

Read: When to avoid RRSPs


When assets are gifted, future income earned from the gift is normally taxed to the gift’s recipient. This allows the person who made the gift to reduce exposure to OAS clawback. This strategy doesn’t work in all cases: gifts to a spouse or a CLP trigger attribution rules, which tax future income in the hands of the gifting spouse. A similar attribution rule applies to gifts to minor children.

When gifting appreciated assets to someone other than a spouse or CLP, capital gains tax normally applies at the time of the gift. This can trigger an OAS clawback for the year of the gift, but exposure for future years would be reduced. Given that Canadians are living longer, healthier lives, clients should be careful not to gift assets they may need in the future.

Stop working

It doesn’t always pay to work, particularly for those subject to OAS clawbacks. Working seniors can consider ceasing or scaling back their work in lieu of an increased OAS pension. Of course, the value of an increased pension would have to be weighed against the satisfaction derived from work.