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How Seniors Pay Income Tax
Most people know the tax act is exceedingly complicated. It interacts with other programs too and that raises the price.
This graph points out the problem.
The idea of amounts lost to tax includes other factors where you lose based on your income. In particular, you will notice the lowest income people lose the most per dollar of income.
Their first $2,000 of income over old age security costs $1,996 in Ontario. The next $8,000 costs at least 75% as Old Age Security supplement is eroded. That then drops to 50% and stays there until it is all recovered at around $20,000 of personal income. The total loss wobbles around as various other credits are clawed back. HST and Ontario Trillium primarily. Some low income seniors will find income affects rent subsidies.
At around $32,000 of personal income the age exemption disappears gradually at a cost of $30 per thousand until it is gone at about $92,000 including OAS.
At $81,000 the OAS itself disappears gradually until it is gone by the low $130,000s. From there on the cost is like the tax tables except for a $150 charge for Ontario health tax at $200,000
Thing to think about
For most seniors, there are four tax brackets they can think about, In Ontario there are more than a dozen even if you exclude the HST and other refundable credits.
Effective Bracket #1 – Very High parts of it are over 75%. It runs from no income to total income including old age security of $27,000. Income taxes would cost about $600. But that extra $20,000 of income has a price too. More than $13,000.
In some situation, they might be able to safely transfer their investment income to their children or run the capital into a Tax Free Saving Account. There could be other risks using the children so be careful. They might have a judgement from a car accident or the like. No senior should have investment income outside a TFSA. Be sure your parents are aware. For those that use children to earn the income, If the child earns less than $80,000 their tax rate is less than half of the parents’ even though their income appears to be almost four times higher.
Effective Bracket #2. Give or take -33% runs from $27,000 to $81,000 and varies between 24% and 35%. Most seniors fall into this bracket. A TFSA may help but pensions and Registered Retirement Income Funds can only be altered slightly.
Effective Bracket #3 Over 40% and running from 81,000 to about $132, 000. The tax table claims the rates are between 30% and 43% but no. As Old Age Security goes away the rates are closer to 40% to 45%. throughout. Again a TFSA may help. Be very careful with Qualifying Dividends. The kind you get from publicly treaded companies. Many people in this age group like to own these high yield, dividend paying stocks. The tax credit sharply reduces the apparent income tax. But, you pay tax based on a “grossed up” amount. Essentially the income the corporation earned. You pay tax on the grossed up amount and deduct a tax credit about equal to the taxes they paid. It’s called corporate integration but doesn’t account for the loss of OAS. If you have income of $85,000 before the dividend, you will pay your normal tax on the dividend, but will lose more than you expect because of the gross-up. The OAS clawback sees $1,380 not the $1,000 you received. The extra $380 that appears has a price tag of nearly an additional $40. About an extra 4% on your tax bill.
Effective Bracket #4 – 50% running from $133,000 on. It has a little at 43% and most of the rest above 48%. At $220,000 it is 53.5%
Not many have to worry. Except!
When to worry
In your final tax return all of your deferred tax comes due. The full value of RRIFs and pension plan payouts are the biggest, Built up capital gains on stocks can matter. Remember the the 10,000 shares of Apple you bough at $2.00, Good one. Until now. Then you will know what it means to suffer a profit.
The problem of course is it goes on the end of your income in the year of death. It is extremely unlikely it will cost less than 40% and more likely 50% The defence is to anticipate the problem and invest in a solution. One of them is to use up the lowest brackets by drawing income from a RRIF earlier than you must. You might pay 30% more now and save 50% later. This might not work very well if you are 70, but it does as you grow older. At 4% after taxes, you must live twelve years before it breaks even. Start thinking about it around 80 or if your health begins to fail.
Never die late in a year. If you have annual income of $75,000 and die on December 31st, your ending tax bill will be $12,000 more than it would have been had you died on first of January that year. Not easy to manage.
Think about diverting some of your cash into a life insurance product. They’re tax exempt and can have a very interesting effect on estates values. It usually pays to move fixed income investments. Just an arithmetic problem, but one that pays well when it works.
The bits to take away.
Your parents are likely in a much higher tax bracket than you are. There may be some value to integrate your situations. Be sure it is still risk proof for them.
Split income so both spouses avoid the OAS Clawback. One earning $145,000 and the other earning $15,000 costs $10,000 extra. Understand how pension splitting and interspousal loans work.
Be cautious with qualifying dividends. They cost more than they seem to cost.
Anticipate. You can influence the future if you can estimate how it will look. That’s what estate planning models are for.
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I build strategy and fact-based estate and income plans. The plans identify alternate ways and alternate timing to achieve both spending and estate distribution goals. In the past I have been a planner with a large insurance, employee benefits, and investment agency, a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business. I have appeared on more than 100 television shows on financial planning, have presented to organizations as varied as the Canadian Bar Association, The Ontario Institute of Chartered Accountants, The Ontario Ministry of Agriculture and Food, Banks – from CIBC to the Business Development Bank.
Be in touch at 705-927-4770 or by email to don@moneyfyi.com
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