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 Your
Money Matters
October
2012
Issue
Fight the Clawbacks
Reduce line 234 to
maximize income in retirement
Canadians age 65 and older may qualify for many valuable government
benefits – Old Age Security and the Age Credit are examples.
However, if the income reported on line 234 of your federal income
tax is too high, these benefits can be clawed back and, in some
cases, forfeited altogether. This can result in the loss of
thousands of dollars in benefits.
A look at the issue and the opportunities
Avoiding clawbacks involves more than simply creating tax credits –
which reduce taxes owing. It is important to look at ways to reduce
reported income. However, when retirement arrives, most of the
familiar deductions – such as RRSP contributions, pension plan
contributions, child care expenses and union dues – are no longer
available.
Consider the amount reported on your return
Income of $10,000
|
Source |
%
Included on tax return |
$
Amount reported |
|
Eligible
dividends1 |
138 |
13,800 |
|
GIC/Bonds |
100 |
10,000 |
|
Capital Gains |
50 |
5,000 |
|
Income fund with
return of capital (ROC) |
402 |
4,000 |
|
Prescribed life
annuity |
153 |
1,500 |
|
Mutual/segregated
fund withdrawals |
2.54 |
250 |
|
Series T mutual fund |
05 |
0 |
1Dividends
paid by public corporations qualify as “eligible dividends”
and are included at 138 per cent for 2012 and beyond. Non-
eligible dividends are included at 125 per cent.
2Tax
percentage will vary depending on the fund and may vary from
year to year.
3Taxable
percentage approximated for a 65 year-old female.
4Taxable
percentage in year one; grows to 20 percent in year 10.
Assumes a five per cent rate of return on an investment of
$200,000. Does not take into account year-end distributions or
allocations.
5Income
is considered ROC until the adjusted cost base (ACB) falls to
zero, at which point it is considered capital gains. Does not
take into account year-end distributions. |
Here are two solutions for achieving this goal
Carefully structure your non-registered income
Active management of income-generating investments can significantly
affect the way your income is taxed, and may help reduce clawbacks.
The example based on $10,000 of non-registered investment income,
shows the impact of different types of investment income.
As you can see in the chart, dividend income can be the least
“income-friendly” to retirees because the grossed-up amount is
reported on your tax return. Although the dividend tax credit
provides preferential tax treatment, the grossed-up amount
exaggerates the total income on line 234.
To maximize benefits and retirement income, you should identify
investments that could be restructured for more favourable tax
treatment. Examples include exploring the advantages of prescribed
annuities, withdrawals from a mutual fund or segregated fund
contract, or distributions from a series T mutual fund.
Create dollar-for-dollar tax deductions
Although most of the familiar deductions are no longer available in
retirement, there are still appealing options to consider in order
to generate deductions to reduce line 234.
RRSP top-up: If you have unused RRSP room, you could make a final
lump-sum contribution prior to converting your RRSP to a RRIF. The
resulting deductions can then be spread over several years.
Borrow to invest: You can create a tax deduction by using RRIF or
other discretionary income to pay the interest on funds borrowed to
invest. This strategy is ideal for investors with a higher risk
tolerance and with discretionary income not needed for living
expenses.
If you are at or near retirement and would like more information
about reducing line 234 of your federal income tax return in order
to avoid clawbacks and maximize your government benefits, contact
us, we can help you out.
Borrowing to invest is appropriate only for investors with higher
risk tolerance. You should be fully aware of the risks and benefits
associated with investment loans since losses as well as gains may
be magnified. Your investment will vary and is not guaranteed.
However, you must meet your loan and income tax obligations and
repay your loan in full. Please ensure you read the terms of your
loan agreement and the investment details for important information.
The dealer and advisor are responsible for determining the
appropriateness of investments for their clients and informing them
of the risks associated with borrowing to invest.
Article provided by Manulife Solutions Magazine
Theresa Wever and the Money Concepts Team
Commissions,
trailing commissions, management fee and expenses all may be
associated with mutual fund investments. Please read the prospectus
before investing. Mutual funds are not guaranteed, their values
change frequently and past performance may not be repeated.
Insurance products provided through multiple insurance carriers.
Mutual fund products provided through Investia Financial Services
Inc.
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