The clawback of government benefits can have a significant impact on your retirement income. Some careful RRSP planning as age 71 approaches, however, can help reduce taxable earnings in retirement – and reduce the clawback of government benefits.
The tax deductibility of contributions is one of the most valuable features of an RRSP. If you are approaching age 71 and closing out your RRSPs, the tax benefits associated with RRSP contributions can gain even greater importance.
Because RRSP tax deductions can be carried forward indefinitely – long after your RRSPs have closed – a final year RRSP contribution can be an important tool for lowering earned income in retirement and reducing the impact of any clawbacks on income-tested government benefits such as Old Age Security (OAS).
An in-depth look at the issue and the opportunities
If you are turning 71, there are two situations in which you can make allowable RRSP contributions before you close your RRSPs by December 31 of that year:
1. You have not maximized your RRSP contributions in previous years and have unused contribution room that has been carried forward.
2. You have earned income in your final RRSP year that generates RRSP contribution room for the following year.
In general, you should take advantage of every contribution opportunity available to you before closing your RRSPs. By reducing taxable earnings, you can reduce the clawback on income-tested government benefits.
The final year RSP contribution strategy
If you have not maximized your RRSP contributions in previous years and have unused RRSP room, you can make a lump sum contribution before closing your RRSP. The resulting tax deduction does not have to be used on that year’s tax return. Instead, deductions can be used at any time in the future, whenever they are the most beneficial for you in reducing taxable earnings. The clawback of Old Age Security benefits is 15¢ for each dollar of income in excess of a certain threshold (approximately $67,000).
In this example, Ruth is making a $50,000 deposit, and has an annual income of $70,000: Additional RRIF payment ($3,690) after tax @ 32% (RRIF minimum at age 71 = 7.38%) = $2,509 Tax savings at $5,000 for 10 years = $1,600
Additional OAS benefit = $197
The extra $4,306 in additional income and tax benefits is equivalent to a GIC return of 12.6 per cent on Ruth’s $50,000 investment.
The over-contribution strategy for those turning 71 in the current year
Even if you have no carry-forward RRSP contribution room, but have current year earned income that will generate RRSP contribution room in the following year, you should consider a final December over-contribution before closing your RRSP. To take advantage of the contribution room, you can make a contribution during December, before the RRSP is officially closed. Since the contribution is being made in December and the current year’s RRSP room has been maximized, an over-contribution penalty of 1% per month applies on any amounts in excess of $2,000.
Ideal Candidates
Those who are approaching age 71 with unused RRSP contribution room
Those who have earned income in the year they turn age 71 that generates RRSP contribution room in the
following year
Those for whom a tax deduction in retirement will either increase their eligibility for tax credits or reduce
the impact on their income-tested government benefits subject to a clawback
If you are getting ready to transfer your RRSPs to a RRIF, you should consider:
The amount of earned income you have for the year
Any unused RRSP room
Your final contribution or over-contribution can make a significant difference.
Remember to always consult your advisor before taking any action.
Written by Stuart Kirk, CIM
Stuart Kirk is an Investment Funds Advisor with Manulife Securities Investment Services Inc and a Retirement Planning Specialist with Precision Wealth Management Ltd. The opinions expressed are those of the author and may not necessarily reflect those of Manulife Securities Investment Services Inc or Precision Wealth Management Ltd. For comments or questions Stuart can be reached at HYPERLINK “mailto:stuart@precisionwealth.ca” stuart@precisionwealth.ca or 250-954-0247.
