Every Canadian receives the Old Age Security (OAS) from the federal government when they turn 65 years old. Financial support started as an anti-poverty measure but has become an important aspect for seniors in their post-work lives.
Retirement experts say the benefit from the income security program dedicated to Canadians 65 and above is about 14% of the average pre-retirement income. However, the gift has a drawback. The Canada Revenue Agency (CRA) can recover partial or the entire benefit amount through the 15% OAS clawback.
A retiree’s annual income must not exceed the minimum threshold or reach the maximum so as not to trigger the dreaded recovery tax. For the income year 2021, the minimum income recovery threshold is $79,845, while the maximum is $129,260.
Assuming your potential income this year is $90,000, you’ll exceed the minimum threshold. The CRA will claw back 15% of the excess amount ($10,155) or $1,523.25. If your income touches the maximum, you get zero benefits. Fortunately, such risks are avoidable. Canadian seniors have ways to avoid the CRA’s clawback and even earn $377.50 per month.
Under Canada’s tax system, income derived from employment, self-employment, investments, rental properties, property sale, pensions, and other income are taxable. Hence, seniors with higher net incomes are in danger of entering the clawback zone.
If you expect your income to be too high, the suggestion is to defer the OAS payment for up to five years or until 70. The voluntary deferral translates to a 36% permanent increase in the benefit amount. The better alternative for seniors who can’t afford to wait is to create income the CRA can’t touch.
The vehicle to generate non-taxable income is the Tax-Free Savings Account (TFSA). Remember, all interest, capital gains, and dividends earned inside a TFSA do not count as taxable income. Even withdrawals from the account are not subject to tax.
Furthermore, income received in or withdrawn from a TFSA will not affect eligibility to income-tested government benefits programs. TFSA balances grow faster, too, because money growth is tax-free.
Create non-taxable income
Most TFSA investors use their contributions to purchase income-producing assets. You can put together a basket of dividend stocks that yield an average of 6%. If you turned 18 in 2009 and haven’t opened a TFSA, the accumulated or available contribution room in 2021 is $75,500.
You can generate $4,530 in annual tax-free income ($377.50 per month). It should put you away from harm’s way or the OAS clawback. If you want to start with a bang, pick Pembina Pipeline (TSX:PPL)(NYSE:PBA). The energy stock pays a juicier 6.44% dividend.
Apart from the generous dividends, the payouts of this $21.48 billion energy infrastructure company are monthly, not quarterly. You churn money faster because you can reinvest dividends or buy more shares 12 times in a year instead of four.
While the headwinds in the energy sector could be intense at times, the long-term, fee-based, and extendible contracts shield Pembina from volatility. The dividend payments come from internally generated funds and not dependent on commodity exposures.
Nullify the impact
Seniors hate the OAS clawback because it reduces retirement income. However, it’s not a lost cause. They can maximize TFSA contributions every year to keep creating non-taxable income that should nullify the recovery tax’s impact.
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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 Christopher Liew has no position in any of the stocks mentioned. The Motley Fool recommends PEMBINA PIPELINE CORPORATION.