Canadian seniors have an interesting opportunity to boost earnings on their savings while protecting Old Age Security payments against the OAS clawback.
OAS clawback rules
The Canada Revenue Agency hits retirees with a pension recovery tax on OAS pensions when net world income breaks above a minimum amount. The threshold to watch in 2020 is $79,054. At that point, every extra dollar in income triggers a 15 cent clawback on the following year’s OAS pension.
The amount of the pension recovery tax continues to rise until the full OAS is affected. That occurs at net world income of $128,149 for the 2020 income year. So, a senior who has net world income of $99,054 in 2020 would see their OAS payment for the July 2021 to June 2022 period reduced by $3,000.
Now, people might say that someone who has retirement income above $79,000 is in good shape. It is certainly a decent income, but life isn’t getting any cheaper for pensioners. Income tax has to be considered, so there might not be a lot left over each month.
For example, the combined 2020 federal and provincial marginal tax rate in Ontario is about 31.5% at $79,000. It then climbs quickly, breaking above 43% on income over $97,069. Getting hit with the 15% OAS clawback on top of the higher income taxes might not seem fair.
After all, it is called the Old Age Security pension.
Retirees have limited options to reduce taxable income. They pay tax on company pensions, CPP, OAS, RRSP withdrawals, and RRIF payments. The CRA gave seniors a 25% reduction on the minimum RRIF withdrawal for 2020, but that is probably a one-off decision. Income from investments held in taxable accounts is also used by the CRA to determine net world income. When you add all the earnings sources together, it might not take long to hit the $79,000 mark.
TFSA option to avoid the OAS clawback
Seniors have one useful way to earn investment income without getting bumped into a higher tax bracket. They can hold investments inside a TFSA. The cumulative contribution room in 2020 is up to $69,500 per person. This gives a retired couple as much as $139,000 in TFSA room.
The CRA does not tax any gains that occur inside the TFSA. In addition, it doesn’t count money taken out of the TFSA towards its calculation of net world income to determine the OAS clawback.
Best stocks to hold in a TFSA
A number of Canada’s top dividend stocks appear reasonably priced today. The pandemic might cause ongoing volatility in stock prices, but solid buy-and-hold picks with reliable dividends should be able to ride out the storm.
For example, Telus and Fortis recently raised their dividends, despite the challenging times. Enbridge appears oversold today and provides a very attractive yield. Bank of Nova Scotia is another top dividend stock that looks cheap.
Advisers recommend having a balanced portfolio. An equal investment in these four stock at the time of writing would provide an average yield of 5.75%. This would generate about $8,000 per year in tax-free income for retired couples on a combined $139,000 in TFSA funds. That works out to roughly $667 per month.
The bottom line
The TFSA is a useful tool to earn investment income without putting OAS payments at risk of the CRA clawback. The TSX Index is home to many top dividend stocks that appear attractively priced right now and would be solid picks for a TFSA income portfolio.
