The article “How to avoid OAS clawback when you’ve had a temporary increase in income.” was originally published in MoneySense on September 14, 2021. Photo by yerling villalobos on Unsplash.

A one-time bump in Sam’s income triggered an Old Age Security benefit clawback, and he wants to know if there is a remedy.

Q. I liquidated a large mutual fund in 2020 to transfer to an ETF with lower fees. Of course, capital gains caused my 2020 income to increase to beyond the bottom threshold for OAS recovery. I understand there is a form to fill to say next year’s income will be lower. However, if I do not fill that form, does everything “come out in the wash” for subsequent years’ tax returns? In other words, would the lost benefit become a “credit” that is then returned to me?

A. Old Age Security (OAS) is a government pension for those aged 65 and older that is means-tested—in other words, whether or not you receive it is dependent on your income. Seniors with a low income may be entitled to a top-up called the Guaranteed Income Supplement (GIS); and at the other end of the scale, recipients with a high income may have their Old Age Security reduced due to an OAS recovery tax or clawback.

OAS clawback applies in 2021 for those whose net income on line 23600 of their tax return exceeds $79,845. A taxpayer must repay OAS at a rate of 15% of income exceeding this threshold. OAS is fully clawed back at $129,581 of income.

There are two ways that OAS recovery may impact you, Sam. The first is if your income exceeds the clawback threshold on your tax filing. In this case, there is a social benefits repayment that reduces your refund or increases your balance owing by increasing the calculation of total tax payable.

Your previous year’s tax return also impacts your OAS pension from July of the filing year to June of the following year. If your net income exceeds the recovery threshold, your subsequent OAS payments will be reduced; this is not necessarily a permanent reduction—it applies only for the applicable 12-month period. On your subsequent tax return, if your income is below the threshold, the OAS reduction will be credited back on a dollar-for-dollar basis and increase your overall tax refund or reduce your balance owing. The OAS reduction is considered a prepayment of income tax and is reported in box 22 (income tax deducted) of your T4A(OAS) tax slip.

There is a form that can be filed as a “Request to Reduce Old Age Security Recovery Tax at Source” called a Form T1213(OAS). The form is filed with the Canada Revenue Agency (CRA) and is typically processed within two months. It is used in a case like yours, Sam, to estimate your current year’s income in the event it will be lower than last year. If approved, the CRA forwards the request to Service Canada, which administers the OAS program, to reduce or eliminate the OAS recovery tax.

To answer your question, it does sort of “come out in the wash”, so the T1213 filing may not be necessary. For some OAS recipients, filing the form can be helpful to ensure they do not see an interruption in their monthly OAS payments, especially in the case the decreased pension payments may cause financial hardship.

You may have been able to reduce or avoid OAS clawback by realizing the capital gain on your mutual fund over more than one year. That said, tax should be a secondary consideration when making investment decisions. If considering a sale of a taxable investment in a non-registered account towards the end of the year, a taxpayer could potentially sell in December and January to split the sale over two tax years.

Paying capital gains tax to sell a high-fee mutual fund and invest in another lower cost investment—an exchange traded fund (ETF), in your case, Sam—may well be worth it. The short-term hit from the capital gains tax may be made up before long with lower fees. The same short-term pain for long-term gain may also apply for an investor who is overexposed to a certain stock or sector. Sometimes, paying tax can enable you to reduce risk and better diversify your portfolio.

Investors should look for ways to invest that balances tax payable, fees and investment strategy. OAS pensioners can consider filing Form T1213(OAS) to request a reduction in their OAS recovery tax but should not be worried that a temporary OAS clawback is necessarily a permanent one.

Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.