When Canadians gather together the information slips, receipts, and other documents needed to prepare and file their annual income tax return, their biggest concern is likely whether completing that return will result in the need to pay a tax amount owing. Taxpayers who are recipients of Old Age Security (OAS) benefits share that concern, of course, but they can face an additional unpleasant result when completing their tax return – finding out that they are subject to the OAS recovery tax, or clawback.
To understand how the OAS clawback works, a bit of background is helpful. The Old Age Security program is one of the two major federal retirement income programs in Canada – the other being the Canada Pension Plan. The two programs differ in two significant ways. First, while the Canada Pension Plan is funded by employer and employee contributions, OAS benefits are financed entirely out of general government revenues. Second, CPP retirement benefits are based on the amount of contributions made throughout the recipient’s working life and are unaffected by their income while receiving those retirement benefits. OAS benefits, however, can be recovered, or clawed back, by the federal government where the recipient’s income exceeds a prescribed threshold.
Most taxpayers, especially those over 65, have heard of the OAS clawback, but few are familiar with how it works in practice. While the rules governing the administration of the clawback can be confusing, the concept is a (relatively) simple one. Anyone who receives OAS benefits during a tax year and has net income for that year over a specified dollar amount threshold is required to repay a portion of the OAS benefits which were received during that year. Generally, that repayment is effected by reducing the amount of OAS benefits paid to the recipient throughout the next benefit year.
For example, an individual who receives full OAS during 2024 and has net income for the year over $90,997 will be subject to the clawback. They must repay OAS amounts received at a rate of 15 cents (or 15%) of every dollar of income over the clawback income threshold, as in the following simplified example.
The OAS clawback threshold for 2024 is $90,997.
If the individual’s income in 2024 was $98,000, then repayment would be 15% of the difference between $98,000 and $90,997:
$98,000 - $90,997 = $7,003
$7,003 x 0.15 = $1,050.45
The individual would have to repay $1,050.45 for the July 2025 - June 2026 period.
The federal government becomes aware of an individual’s income for 2024 only once the tax return for that year is filed, usually by April 30 of 2025. At that time, it will become apparent that $1,050.45 in OAS benefits received must be repaid. Consequently, in the following benefit year (which will run from July 2025 to June 2026), OAS benefits received will be reduced by $87.53 per month ($1,050.45 divided by 12 months).
This year, the OAS clawback affects only individuals who have an annual income of at least $90,997, much higher than the average income for a senior in Canada, and it’s arguable that at such income levels the clawback requirement does not impose any real financial hardship. Nonetheless, the OAS clawback is a perpetual irritant to those affected by it, perhaps because of the sense that they are being penalized in retirement for having lived frugally or been good managers of their finances during their working years, in order to put aside savings for a financially comfortable retirement, or to leave an inheritance for their children.
While any sense of grievance can’t alter the reality of the OAS clawback, there are strategies which can be put in place to either minimize or, in some cases, entirely eliminate one’s exposure to that clawback. Some of those planning considerations are better addressed earlier in life, prior to retirement; however, it’s not too late, once one is already receiving OAS, to make arrangements to avoid or minimize the clawback in future years.
In all cases, no matter what strategy is employed the goal, as it is with much of individual tax planning, is to “smooth” one’s income from year to year, so that net income for each year comes in under the OAS clawback threshold and, not incidentally, minimizes exposure to the higher federal and provincial income tax rates which in most cases apply once taxable income reaches between $90,000 and $100,000.
The starting point for taxpayers who are approaching retirement is to determine how much income will be received from all sources during retirement, based on CPP and OAS entitlements, any savings accrued through an RRSP, and any amounts which may be received from a private pension plan. For planning purposes, the age at which those income streams will come “online” can then be determined and arranged to produce the best result for both tax and OAS clawback purposes.
Anyone who has an RRSP must begin receiving income from those savings in the year after that person turns 71. However, it’s possible to begin receiving income from an RRSP at any time. Similarly, an individual who is eligible for CPP retirement benefits can begin receiving those benefits anytime between age 60 and age 70. OAS benefits can be received as early as age 65 or deferred up until age 70. For both CPP and OAS, the benefit amount increases for each month that receipt of that benefit is deferred.
Once the amount of annual income is determined, strategies to smooth out that income can be put in place. Those strategies could include arranging to receive OAS and CPP benefits at an earlier date or withdrawing amounts from an RRSP prior to age 71. The latter strategy will reduce the total amount within the RRSP and so thereby reduce the likelihood of having a large “bump” in income when required withdrawals kick in at age 72.
Taxpayers are sometimes understandably reluctant to take steps which they view as depleting their RRSP savings, but receiving income from an RRSP doesn’t mean spending that income. While tax has to be paid on any withdrawals (no matter what the taxpayer’s age), the after-tax amounts received can be contributed to the taxpayer’s tax-free savings account (TFSA), where they can compound free of tax. And, when the taxpayer has need of those funds, in retirement, they can be withdrawn free of tax and they won’t count as income for purposes of the OAS clawback.
The same strategy works for taxpayers who have opened a registered retirement income fund, or RRIF. All taxpayers who have an RRSP are required to collapse that RRSP by the end of the year in which they turn 71 and most taxpayers then transfer the balance of funds in the RRSP to an RRIF. Once an RRIF is opened, the holder of the RRIF is required to withdraw a specified percentage of funds from the RRIF each year (with that percentage increasing each year), and to pay tax on those withdrawals. That’s the case even where the taxpayer has no need of the funds and even where, as with the OAS clawback, receiving those funds can affect OAS benefit eligibility.
Taxpayers who have an RRIF and are age 65 or over can’t avoid making the withdrawal and paying tax on such amounts. However, where there is no immediate need for those funds, they can (like RRSP withdrawals) be contributed to the taxpayer’s TFSA. And, once again, those amounts can be invested and can grow tax-free. (If amounts withdrawn from an RRIF were invested outside of any tax sheltered plan, those investment gains would be fully taxed in the year in which they are received.) When amounts (whether original contributions or investment returns) are later withdrawn from the TFSA, no income tax is payable on those amounts and the amounts received will not be included in income for purposes of the OAS clawback.
Taxpayers who are married can also “even out” their income by using pension income splitting, so that neither of them has sufficient income to be affected by the clawback. Using pension income splitting, the spouse who has income over the OAS clawback threshold re-allocates the “excess” income to their spouse on the annual return, and that income is then considered to be income of the recipient spouse, for purposes of both income tax and the OAS clawback. To be eligible for pension income splitting, the income to be reallocated must be private pension income, which is generally income from an RRSP or RRIF, or from an employer sponsored pension plan. CPP and OAS benefit amounts do not qualify for pension income splitting.
There are two reasons why pension income splitting is a particularly attractive strategy for avoiding or minimizing the OAS clawback. First, there is no need to actually change the source or amount of income received by each spouse, as the reallocation of income is “notional”, existing only on the return for the year. Second, no decision has to be made on pension income splitting until it’s time to file the return for the previous year, meaning that spouses can easily calculate exactly how much income has to be reallocated to produce the desired result. More information on the kinds of income eligible for pension income splitting, and the mechanics of the process, can be found on the CRA website at https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/pension-income-splitting.html.
While the concept of planning to smooth out income in order to minimize taxes in retirement and avoid the OAS clawback is straightforward, most retirees have multiple sources of income and determining just how much income will be available from each source in each future year is difficult. However, the federal government provides an extremely useful online calculator which can be used to make that determination. The particular value of that calculator is that, based on inputs provided by the user, it enables that user to run “what-if” scenarios to determine the effect of, for instance, receiving OAS and CPP benefits at the earliest possible time, or by deferring receipt of those benefits for one, two, or more years. Based on the inputs provided by the user, the calculator will determine the amount of income which will be received annually from each income source in each future year. That calculator is available on the federal government website at https://srv111.services.gc.ca/generalinfo/index.
Detailed information on the OAS clawback can be found on the same website at https://www.canada.ca/en/services/benefits/publicpensions/cpp/old-age-security/repayment.html.