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David A. Townsend, CPA, CFP Professional Corporation

"Understanding the OAS Clawback"   an article by David A. Townsend

There is nothing that seems to rile seniors more than the OAS clawback. I sympathize with those who watched their spending, maximized their savings and RRSP's, and now find that they are being penalized for doing all the right things. CRA has also made the rules complicated and convoluted, resulting in a lack of understanding of the clawback and its impact on after-tax income.

Let's walk through the tax effects on 75 year old Mr. Variable who sold a rental property in 2013 and had a large capital gain. His income is usually in the $60K range and therefore below the clawback base amount of about $71K. However, in 2013, his income almost doubled to over $111K. This resulted in $6,021 of his OAS of $6,579 being clawed back on his 2013 tax return.

Mr. Variable's 2013 total tax bill including the clawback was $32,025 (Alberta rates). If there was no clawback (thank goodness for computer programs and overrides to do the calculations!), his bill would have been $28,171. So the additional amount owing is $3,854 — not the clawback amount of $6,021!

For the benefit of math/tax geeks like me, the reason for this is that the OAS clawback is a deduction from income. So there is a 2013 tax reduction of $2,167 ($6,021 at marginal rate of 36%) after the clawback provisions are applied.

Anyway, my experience is that most seniors can live with paying back some or all of their OAS in high income years (i.e. Mr. Variable's 2013 tax year). However, starting in July/14, his OAS is also reduced by about $502 per month. This seems to be the point of contention for most — they feel the subsequent year clawback is unfair.

But many don't seem to understand that this clawback is recorded as tax deducted on their OAS slip. This is claimed back at the end of the year. In the example of Mr. Variable, his 2014 income will go back to $60K and he will not be subject to OAS clawback. But he will be able to claim an additional $3,012 (6 x $502) in tax deductions for the OAS that he never received. This will be shown on his OAS slip. He can also factor that additional tax deduction into his tax installment calculation when he estimates his 2014 tax payable. So cash-wise, he is not out of pocket for 2014. However, he did have to pay an additional $3,854 for 2013.

Now let's look at Ms. Constant is also 75 and in the fortunate position of having an annual income level of $185K. Of course, her total OAS is clawed back annually. In 2013, she had a tax refund of $2,854 after credits for the OAS clawback and installments. Without the clawback provisions, her refund would have been $116. So she is actually $2,738 better off cash-wise when filing her income tax return! Of course, she never received any OAS in 2013 so her cash cost is actually $3,841 ($6,579-$2,738). But based on her income, the clawback means additional tax of less than 2%.

In my research, I found many references to elaborate schemes to avoid the clawback. And I agree that you should plan to avoid or reduce the clawback where possible. However, the tail should not wag the dog. My view is that the time and energy agonizing over the clawback could often be better spent on increasing income — paying more tax on more income still leaves you ahead.

A May 27, 2011 Globe & Mail article "How to avoid the dreaded OAS clawback" states that "the OAS clawback does not actually have a huge negative impact on your income in retirement". In the same article, Daryl Diamond, a Winnipeg financial planner and author of "Your Retirement Income Blueprint", states that "On a net, after-tax basis, it is nominal".

To summarize, the clawback is obviously complicated… perhaps purposely so. But it may not be as punitive as you originally thought.

For those who jump periodically over the threshold, you will pay more tax in the high-income year, but the subsequent OAS reduction is recovered as tax paid. If you are someone who is getting their OAS completely clawed back year after year, you are obviously contributing more annually to the Canadian tax coffers. However, if it is any consolation, you do receive an additional deduction for paying it back.

Contributing Editor to Canadian Money Saver Magazine