Canadian seniors who collect the Old Age Security (OAS) need to realize the importance of keeping an eye on their overall retirement income. If you are approaching retirement, you might be worried about the OAS recovery tax, also known as the OAS clawback.
This pension recovery tax kicks in when a retiree’s net income exceeds a minimum threshold. The number to watch in 2021 is $79,845. The amount is up from $79,054 in 2020. Once your income reaches the threshold, every additional dollar of your income triggers a 15% OAS clawback.
The pension recovery tax continues increasing until the full OAS for the year is accounted for and recovered through a reduction in the OAS in the next payment year. I will discuss three methods you can use to avoid the 15% OAS clawback and maximize your retirement income while keeping it away from the tax-hungry clutches of the Canada Revenue Agency (CRA).
Defer collecting OAS
The default age to begin OAS is 65. However, you can defer collecting your OAS until you are 70 years old. By delaying the OAS by five years, you can receive a 36% increase in your monthly OAS when you begin collecting it. Additionally, you can enjoy the benefit of increasing the minimum threshold that you can earn before not receiving any OAS. Since your benefit will be higher, it will take more time for the CRA to claw it back.
Splitting pension with your spouse
If your spouse or common-law partner’s income is significantly lower than yours, you can use this to your advantage. Consider splitting your pension income with your spouse by up to 50% through your Registered Retirement Income Fund (RRIF), Canada Pension Plan (CPP), annuity income, or pension income to reduce your net income and avoid the OAS clawback threshold.
Focus on your TFSA to reduce OAS clawback
Your Tax-Free Savings Account (TFSA) can be exceptionally helpful in helping you reduce your net income. Any passive income through your TFSA cannot count towards the income that the CRA calculates for your net income in retirement. It means that you can focus on investing in income-generating assets in your TFSA to generate passive income to supplement your regular retirement income and OAS without triggering the clawback.
You need to create a portfolio of reliable income-generating assets to earn significant passive income. High-quality dividend-paying stocks like Bank of Montreal (TSX:BMO)(NYSE:BMO) can be a phenomenal way to build such a portfolio.
BMO is as reliable as any stock can get when it comes to paying its shareholders their dividends. The Canadian bank has an impressive dividend-paying streak spanning almost 200 years! The stock has provided dividend payouts through several periods of economic hardship without fail. The bank’s stability through the years is a testament to its reliability.
Bank of Montreal is a staple investment for many retirement portfolios due to its long-term stability. The bank is susceptible to price movements on the stock market amid uncertainty. However, it retains the ability to continue disbursing its dividend payouts regardless of economic conditions.
Avoiding the OAS clawback requires carefully watching your overall income. If you are concerned about the income from your investments in any taxable accounts becoming a problem to this end, you should consider using any unused contribution room in your TFSA for this purpose. BMO could be an excellent stock to begin building such a portfolio.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.
Fool contributor Adam Othman has no position in any of the stocks mentioned.