Q&A: Early RRSP withdrawal might avoid clawback

Question: I am now 59 and in receipt of a federal government pension. I plan to take reduced CPP next year. I have an RRSP worth about $80,000, mostly in mutual funds paying dividends.

Once I am 65 my pension will be adjusted downward to reflect CPP and I will receive OAS. At that point (even with adjustments and without any RRSP income) I will be subject to OAS clawback.

I would like your comments whether it makes sense for me to annually withdraw some of my RRSP before age 65. I was thinking of withdrawing an amount that keeps me within the second tax bracket. If I don’t need the cash I was thinking of making sure any investment income is in dividends rather than interest. – David H.

Gordon Pape’s answer: Your plan has some merit. Although you’ll be paying taxes on the RRSP withdrawals, the effective rate will be lower than after age 65 because of the Old Age Security clawback, which raises the marginal rate on that income by 15 per cent.

But you do need to be careful about one thing. Under current rules, dividends are “grossed up” by 25 per cent before the dividend tax credit is applied. That will increase to 45 per cent if t Liberal plan for lowering the effective tax rate on dividends is adopted. For reasons that make no sense to me, the grossed-up amount is the figure used in calculating net income, which is the amount that determines whether the clawback will apply. In effect, this means you could be penalized for money you never received. It’s a strange way to run a tax system but that’s the way it is so plan your investments accordingly.

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