An Old Age Security Trap
Question: My question relates to interest income versus dividend income. With the new federal budget in place, and as a 72-year-old senior drawing down about $30,000 out of my RRIF annually, would it make more sense to sell my bonds in my taxable account and buy preferred shares now? This way I can capitalize on my OAS payments.
Gordon Pape answer: Your plan makes sense – but there’s a potential trap you need to watch out for.
As a general rule, it’s a good idea to use tax-advantaged securities in non-registered accounts. Keep the bonds and other interest-bearing securities in the RRIF and use preferred shares, royalty trusts, etc. in your taxable accounts. So what you’re proposing looks like a good idea.
However, you need to take a close look at your total income picture before you make a move. You tell us you’re drawing $30,000 annually from the RRIF. You don’t say anything about other sources of income: CPP, OAS, revenue from your taxable portfolio, etc.
Remember that if your net income exceeds $53,215, the government will start clawing back your Old Age Security payments. What many people don’t realize is that net inme includes the taxable amount of dividends you received – not the actual amount. This is the trap I referred to.
Suppose you are receiviing $10,000 a year in interest income from your taxable portfolio now. You carry out your plan and switch the bonds to preferred shares. For simplicity, we’ll say you now get $10,000 in dividend income instead.
There’s a complicated process for calculating the dividend tax credit that involves “grossing up” the amount of dividends you received by multiplying by 125%. So the taxable amount (which will be included in your net income) is actually $12,500 – even though you only received $10,000.
That might be enough to push you into clawback territory. You’ll have to calculate whether the savings you obtain by switching the interest income to dividend income will be more than enough to offset that.
It certainly would be nice if they’d make the tax system a little easier!