Canadian retirees need to boost their income to keep up with rising living costs, but they don’t want to get bumped into a higher marginal tax bracket or put their Old Age Security (OAS) pensions at risk of being hit by the OAS pension recovery tax.
OAS clawback
Many pensioners don’t realize that the Canada Revenue Agency (CRA) will claw back a portion of their OAS pension if their income is too high. The number to watch for the 2023 income year is $86,912. Every dollar of net world income above that amount is hit with a 15% pension recovery tax.
Once net world income reaches $142,428 for people 65 to 74 years old and $147,979 for those over 75, the full OAS pension benefit is wiped out for the next OAS payment period, which runs from July 2024 to June 2025.
You might think that $87,000 is a lot of income for a retiree, but it doesn’t take long to hit that amount if a person receives a decent work pension, CPP, OAS, and other taxable income that might include Registered Retirement Income Fund (RRIF) payments, income on rental properties, investment income, or even earnings from a part-time job.
TFSA benefits
Avoiding tax is difficult to do legally. However, one way the government helps is to allow all earnings from investments inside a Tax-Free Savings Account (TFSA) to go straight into your pocket tax-free, and the amount is not included when the CRA calculates net work income to determine the OAS clawback.
This is a big deal if your income is near or above the OAS minimum clawback threshold and have interest, dividend, or capital gains coming from investments held in taxable accounts.
The TFSA limit is $6,500 in 2023. Retirees have as much as $88,000 in cumulative TFSA contribution room right now, and the TFSA limit increase in 2024 will be at least another $6,500.
Best TFSA investments for passive income?
Soaring interest rates are hammering people with debt, but they are helping savers by driving up rates being paid on Guaranteed Investment Certificates (GICs). This is great news for retirees who can now get GIC rates of 5-5.5%, depending on the term. At this level, GICs should be part of the TFSA portfolio. As long as the GIC is issued by a Canada Deposit Insurance Corporation member and the amount is in the protected range, there is no risk.
GICs do have some drawbacks. The principal is out of reach for the term of the certificate. This is a problem if you suddenly need to access the money. Also, the rate is fixed for the term. In the event that rates jump considerably, as they have in the past two years, you could miss out on better returns.
Dividend stocks are a popular option for people who want access to the principal at all times and are comfortable taking on some risk. Share prices can fall, and dividends sometimes get cut. However, many top dividend-growth stocks have increased their distributions for decades and currently offer yields above GIC rates.
GIC or dividend stock?
At this point in time, it would make sense to build a diversified TFSA portfolio of GICs and top TSX dividend-growth stocks.
Enbridge and TC Energy are good examples of stocks that have increased their dividends annually for more than 20 years and now offer yields above 7%. BCE offers a 6.7% dividend yield at the time of writing, and Bank of Nova Scotia’s yield is close to 6.5%.
Retirees can quite easily get an average return of 6% right now from a combination of GICs and reliable dividend stocks. On a TFSA of $88,000, this would generate $5,280 per year. That works out to an average of $440 per month in tax-free income that won’t put OAS pension payments at risk of a clawback.
