Here’s a scenario I’ve seen several times in my career as a wealth manager. A retired couple that receives two full CPP payments and two full Old Age Security (OAS) payments is able to fully split their income for tax purposes. Then one spouse dies. The survivor only receives one CPP payment, no OAS, and often has a higher tax rate on less family income because they now have one combined RRIF account that must withdraw more funds on a single tax return. It hardly seems fair, because it isn’t.
The scenario highlights just one of a number of thoroughly unjust tax policies that negatively affect hundreds of thousands of Canadians each year. Many of the policies are particularly harmful to older women because they hit those who are single/widowed and over the age of 65 — a group that contains a much higher percentage of women than men.
As we head into a new decade, and in the spirit of eternal optimism, I am providing a list of four main offending policies in the hope that some political titans vow to fix them.
Without further ado, here are the festering four:
1. Income splitting of a defined benefit pension, prior to age 65
THE SITUATION: If you receive a defined benefit pension at any age, you can split the income with your partner for tax purposes. However, if you convert some or all of your RRSP to a RRIF and withdraw money before age 65, you can’t split the income. You have to wait until age 65.
WHY IT MATTERS: Income splitting is another way of simply saying “pay less in taxes.” If you can income split you will most likely keep more of your pension money than if you can’t. As a simple example, if one person earns $120,000 in Ontario, their tax bill will be $32,895 (with no deductions). If instead, that person is able to fully split income and two people now show $60,000 in income, the total tax bill is $22,050. On the same amount of income, the tax bill is $10,845 lower.
WHO IT AFFECTS: Everyone who does not have a defined benefit pension. These days, most employees who have a defined benefit pension work for the government or a quasi-governmental organization. The private sector now has a very low percentage of employees in a defined benefit pension. To oversimplify, working for the government provides a sizable unfair tax advantage for those under 65 compared to those working in the private sector, without a defined benefit pension. It also benefits couples over singles.
HOW TO FIX IT: Apply the same income splitting age on RSP/RIF withdrawals as on defined benefit pension payments. If that is deemed too expensive for the government, do an income-splitting cap of something like $20,000, but apply it equally to all those of a specific age regardless of what type of retirement pension plan they have.
2. Couples tend to receive more dollars per person than singles in Old Age Security (OAS)
THE SITUATION: Current OAS is more than $7,300 per person per year. If you are collecting OAS starting at age 65, your income can be up to $79,000 before any of your OAS is clawed back. At an income of $128,000 it will be fully clawed back.
WHY IT MATTERS: This is significantly unfair to retired singles. If you are single and your income is $130,000, you will collect no OAS. If you are a couple with household income of $130,000, and you can fully split your income, you will collect about $14,700 of OAS every year indexed to inflation.
WHO IT AFFECTS: Single/widowed seniors get the short end of the stick, and they are more than twice as likely to be female. I have seen many cases where a couple receives two full OAS payments. When one passes away, the survivor suddenly receives $0 in OAS because all of the income (usually RIF income) now sticks to one person instead of being split. According to Statistics Canada roughly 70 per cent of those in long-term care and retirement residences are female. As far as private residences (houses, apartments, condos), 40.2 per cent of women aged 80 to 84 live alone, while only 18.6 per cent of men in the same age group live alone. However you slice it, it appears that at least twice as many single seniors are woman as opposed to men.
HOW TO FIX IT: Have the OAS clawback be based on a dual-person rate or a single-person rate, such that two-person families might see a little more clawback and single-person families see a little less. Given that the current clawback kicks in at $79,000 for one person, the two-person ‘family’ rate could be set at a little less than double that, say $145,000 (with full splitting, the current cutoff for two people is effectively $158,000). The new single-person clawback cutoff could then be raised to about $85,000. The idea is to massage the clawback criteria so that people are much less likely to go from double OAS payments to zero when one dies or gets divorced.
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3. Effectively losing the CPP Survivor Pension
THE SITUATION: If two people in a couple are both collecting a full Canada Pension Plan benefit and one of them dies, the other will receive a one-time $2,500 death benefit, and then they will lose the entire CPP payment of the person who died. On the other hand, if the same couple has one person who is collecting a full Canada Pension Plan and their partner never paid into the plan and collects $0 of CPP, and either of them die, the net result is that they will continue to collect one full CPP amount. The reason is that no individual is able to collect more than 100 per cent of a CPP benefit. However, if one person is currently receiving less than 100 per cent, and let’s say her partner dies, that person is able to top up her CPP payment up to 100 per cent out of the amount that was being collected by her partner.
WHY THIS MATTERS: A full share of CPP in 2019 is over $13,800 a year. This is a significant amount of money. To go from receiving up to $27,600 a year and having it drop to $13,800 is a big impact when both people have contributed a lot to CPP over the years.
WHO IT AFFECTS: These rules almost provide an incentive to only have one working partner over the years. It hurts couples in which both partners worked full time. It especially affects couples who both work and in which the male is much older than the female, as this will lead to a longer period of one CPP payment as opposed to collecting two.
HOW TO FIX IT: Most defined benefit pensions have a survivor pension that pays out 60 per cent to 70 per cent of the pension to a surviving partner. You could change the CPP so that if a survivor is already receiving a full CPP payout based on her own contributions and her partner dies, she should receive 60 per cent of their partners’ CPP as well. Essentially make the maximum payout to an individual up to 160 per cent of a full CPP payout. In order to fund it, we could slightly lower a full CPP payout for everyone. In cases where only one person contributed to CPP, and one of the couple dies, then that person would be capped at receiving 100 per cent of the CPP. In this way, a lifetime of CPP contributions doesn’t go for naught if one spouse dies.
4. The Canadian dividend gross up costs OAS dollars
THE SITUATION: In simple terms, Canadian dividends from public corporations are more tax efficient than interest income and foreign dividends. For example, at $70,000 of income in Ontario, the marginal tax rate on income or foreign dividends is 29.65 per cent but the marginal tax rate on eligible Canadian dividends is just 7.56 per cent. This is a very big positive for investing in Canadian stocks that pay dividends. However, there is one nagging problem. The CRA likes to make things complicated, and in order to sort out something called tax integration for corporations, they have set up a complicated way to tax Canadian dividends. The tax formula is to ‘gross up’ a dollar of Canadian dividend income by 38 per cent and then apply a dividend tax credit to get to the right amount of taxation on the dividend. When the CRA determines your income for a variety of income tests, they take your net income — which includes the grossed up dividend income.
WHY IT MATTERS: We discussed the minimum OAS clawback at net income of $79,000. Let’s say you have $70,000 of taxable income from RRIFs, interest and global dividends. At this amount you would receive full OAS. Instead, if you had the same $70,000 of income but it was all Canadian dividend income (an unlikely scenario but good for making this point), it would be grossed up by 38 per cent, and your net income would be considered $96,600. Now your OAS would likely be clawed back by $2,640 a year.
WHO IT AFFECTS: This is an issue that exists for no good reason. At the end of the day, it isn’t the worst of the festering four, but does slightly punish seniors who invest in Canadian companies that pay dividends, especially those who check in around the $80,000 income bracket and are already having some OAS clawed back.
HOW TO FIX IT: I am sure that the strategies around corporate tax integration are complicated, but on a personal tax return, is it that hard to simply tax Canadian dividends using personal tax rates without any gross up? If there was no gross up calculation on a personal tax return, then there is no longer an OAS net income issue. Problem solved.
Ted Rechtshaffen, MBA, CFP, CIM, is president and wealth advisor at TriDelta Financial, a boutique wealth management firm focusing on investment counselling and estate planning. firstname.lastname@example.org