Fighting the clawbacks — reduce line 23400

Dividend income can be the least income-friendly to retirees because the grossed-up amount is reported on their tax returns. Although the dividend tax credit provides preferential tax treatment, the grossed-up amount exaggerates the total net income on line 23400 of the federal income tax return.

Canadians age 65 and older may qualify for many valuable government benefits, such as Old Age Security and the age amount credit. However, if the income reported on line 23400 is too high, these benefits can be clawed back and, in some cases, forfeited altogether. This can result in losing thousands of dollars in benefits.

An in-depth look at the issue ... and the opportunities

Avoiding clawbacks takes more than simply creating tax credits that reduce the taxes owing. When retirement arrives, most of the familiar deductions (RRSP, pension, childcare, union dues, etc.) are no longer available. It’s important to look at ways to reduce reported income. 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 income is taxed and may help reduce clawbacks. The following example, based on $10,000 of non-registered investment income, shows the impact of different types of investment income.

Create dollar-for-dollar tax deductions

As mentioned above, on retirement, most of the familiar deductions are no longer available. However, there are still some appealing options.

RRSP top-up 

Those with unused registered retirement savings plan (RRSP) room should make a lump-sum, final contribution prior to converting to a registered retirement income fund (RRIF). The resulting deductions can then be spread over several years. For more information, see “Final RRSP contributions at age 71.”

Borrow to invest

By using RRIF or other discretionary income to pay the interest on funds borrowed to invest, a tax deduction can be created. This strategy is for investors with discretionary income not needed for living expenses. For more information, see “Maximizing discretionary RRIF income by borrowing to invest.”

Ideal candidates

Investors who:

• are retired or near retirement
• want to maximize their government benefits

Take action

To maximize benefits and retirement income:

• identify investments that could be re-structured for more favourable tax treatment
• make withdrawals from a mutual fund or segregated fund contract, where a large portion of the payment is considered a return of capital and the balance is capital gains
• consider the tax efficiencies of Series T mutual funds
• make a lump-sum RRSP contribution before converting to a RRIF
• consider a borrow-to-invest strategy
• evaluate the tax savings of these strategies with our easy-to-use online calculator.
  

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1 Dividends paid by public corporations qualify as eligible dividends and are included at 138%. Non-eligible dividends are included at 115%. 2 Taxable percentage approximated for a 65-year-old female. 3 Taxable percentage in year one, grows to 20% in year 10; assumes a 5% rate of return on an investment of $200,000; doesn’t take into account year-end distributions or allocations. 4 Regular Series T distributions are expected to be all or principally return of capital, which isn’t taxable until the adjusted cost base falls to zero, at which point it’s taxable as capital gains—doesn’t take into account any potential taxable distributions.