Tax managed strategy 4
The clawback of government benefits can have a significant impact on your retirement income. With some careful registered retirement savings plan (RRSP) planning as age 71 approaches, you can 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’re approaching age 71 and closing out your RRSPs, however, 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’re 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:
- You haven’t maximized your RRSP contributions in previous years and have unused contribution room that has been carried forward.
- You’ve 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 impact of this clawback can be significant.
The clawback of Old Age Security benefits is 15 cents for each dollar of income over a certain threshold.¹
Making it work
Final year RRSP contribution strategy
If you haven’t 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 doesn’t have to be used on that year’s tax return. Instead, deductions can be used at any time in the future, whenever they’re the most beneficial for you in reducing taxable earnings.
How it stacks up
As an example, Ruth is making a $50,000 contribution. She has an annual income of $80,000 and a 32 per cent marginal tax rate. Ruth can use her deduction whenever it’s most beneficial. She could spread the deduction over 10 years by claiming $5,000 per year and save $1,600 in taxes each year. The $5,000 annual deduction would also reduce the clawback of her OAS and potentially other income-tested government benefits.
RRSP contributions must be made by December 31 of the year you turn 71. However, RRSP deductions can be carried forward indefinitely and spread out over several years to reduce taxable earnings in retirement.
Over-contribution strategy for those turning 71 in the current year
Even if you have no RRSP carry-forward 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, 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 one per cent per month applies on any amount over $2,000. However, on January 1, the over-contribution disappears due to the RRSP contribution room generated from the current year. You can claim the tax deduction on next year’s return or carry it forward to whichever future year you choose.
How it stacks up
Assume a person has an income of $50,000 with a 32 per cent marginal tax rate (with no penalty on the first $2,000).
Are you over age 71?
Regardless of an individual’s age, if the individual has RRSP contribution room, that person can contribute to a spousal RRSP prior to December 31 of the year the spouse turns 71. The individual can claim a tax return deduction whenever it’s most advantageous. This strategy is particularly attractive if a client anticipates a spouse’s retirement income will be less than the client’s own retirement income.
- People approaching age 71 with unused RRSP contribution room
- Those who’ve 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’re 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.
Investment options with Manulife Investment Management
Manulife Investment Management and its subsidiaries provide a range of investments and services for retired investors.
Mutual funds can help meet your specific financial needs throughout your life. Whether you’re just starting out, accumulating wealth, or nearing/in retirement, mutual funds can provide you with solutions to help build a portfolio that meets your needs.
Segregated fund contracts combine the growth potential offered by a broad range of investment funds with the unique wealth protection features of an insurance contract. Segregated fund contracts can help clients minimize their exposure to risk through income, death and maturity guarantees, potential creditor protection features, and estate planning benefits — all from a single product or insurance contract.
Guaranteed interest contracts (GICs) offer competitive rates plus investment options. Investors benefit from a guarantee on their principal investment, and from several different investment options that can diversify and add flexibility to their portfolio. GICs can be an ideal solution for conservative investors who are looking to help grow their wealth but concerned about minimizing risk.
1 For the current annual payment, visit https://www.canada.ca/en/services/benefits/publicpensions/cpp/old-age-security/payments.html. For the current clawback threshold (recovery-tax), visit https://www.canada.ca/en/services/benefits/publicpensions/cpp/old-age-security/recovery-tax.html.
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