When you are planning your retirement income, you are planning the cash flow you'll draw on for the rest of your life. For Canadians aged 65 today, those resources include Old Age Security, or OAS.
In retirement, OAS pays a current maximum of about $565 per month, or $6,780 per year. This amount is both inflation-indexed and longevity-protected: It will both rise with inflation and last as long as you do (pending any rule changes).
Current retirees over the age of 65 can expect to receive full OAS, less any clawbacks as a result of other taxable income. Those born after March, 1958, will have to wait a little longer – up to age 67 – but the base amount is not expected to change, except for inflation adjustments over time.
Minimizing the OAS clawback
Earlier this month, we explored a financial planning situation in which a fictional retiree, Rebecca, was encouraged to convert her RRSP to a RRIF earlier than required, so she could "smooth" her income over her expected lifetime – and preserve the full amount of OAS she would start to receive at age 65.
In our case study, keeping Rebecca's income under about $71,600 a year means she is entitled to the full $565 a month in OAS income. That's because if you have net income over this threshold, your OAS payments are subject to a special "recovery" tax, or clawback.
The OAS recovery tax is calculated as 15 per cent of every dollar of income over the threshold level, and is added to your marginal rate. This means some seniors pay an effective tax rate on OAS income of up to 60 per cent or even more, when the OAS recovery tax is added to their marginal tax rate.
Thus the argument to manage taxable income to preserve OAS income in retirement is straightforward: It both minimizes high effective tax rates, and reduces the withdrawals you'd otherwise need to make from your own resources.
Your personal retirement income balance sheet
But there is another way to think about the value of OAS income beyond putting more money in your pocket each month – and that's its value on your personal balance sheet. But how do you determine the value today of income received over time?
At the most basic level, if you assume 30 years of life (and thus 30 years of OAS income) past age 65 and you ignore all real-world variables, such as inflation and investment returns, you would need just more than $200,000 to draw down $6,780 per year (as $203,400 divided by 30 is $6,780). This would fully deplete the lump sum over 30 years, leaving nothing behind.
So, one way to think about the value of OAS in retirement might be like a $200,000 addition to your portfolio, albeit one that is not liquid or tradable, leaves no residual value at your death, and is sufficient to fund a retirement horizon of 30 years.
Modelling the value of OAS with an income annuity
A better (or at least more realistic) way to approximate the value today of an asset that produces $6,780 a year in indexed income with no value remaining at the end of life is to compare the stream of OAS income to the monthly payouts from an income annuity.
What is the amount you would need to turn over to an insurance company today to receive an inflation-adjusted $6,780 for life? The answer will depend on whether you are male or female, but it is in the range of $130,000 for a Canadian man aged 65 today, and $150,000 for a Canadian woman (as women have a greater life expectancy than men).
Of course, the price of an annuity will vary based on changes in interest rates and Canadian longevity trends, among other factors – the price today may not be the same next year or next month.
The balance-sheet value of OAS income in retirement
The takeaway? Viewed holistically, your personal balance sheet at retirement includes an allocation to OAS. So when you arrange your financial affairs to avoid OAS clawbacks, that's another way to think about the value you're protecting – in addition to saving tax and reducing portfolio withdrawals.
Alexandra Macqueen, CFP, teaches and writes about finance in Toronto. She is co-author, with Moshe Milevsky, of Pensionize Your Nest Egg: How to Use Product Allocation to Create a Guaranteed Income For Life. You can follow her on Twitter at @MoneyGal.
A Valuable Asset
Here's the approximate amount you would need to turn over to an insurance company today to receive an inflation-adjusted $6,780 per year (the current Old Age Security maximum) for life.
Notes: Cost of $6,780 in annual annuity income, starting at age 65. For an annuity purchased in a non-registered account with a 10-year guarantee and yearly indexation at 2 per cent. Value based on average of top five quotes.
Source: CANNEX Financial Exchanges