TAX, RETIREMENT & ESTATE PLANNING SERVICES. Clawback calculator user guide

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1 TAX, RETIREMENT & ESTATE PLANNING SERVICES Clawback calculator user guide

2 Table of contents Introduction... 3 Fully taxable and investment income Fully taxable income... 4 Investment income... 5 Deductions and expenditures Deductions from income... 6 Expenditures that generate tax credits... 7 Current spendable income Current tax rates... 8 Restructuring your investment income... 9 Assumptions Assumptions regarding non-refundable credits Assumptions regarding non-refundable dividend tax credit... 13

3 Introduction This calculator is designed to illustrate the difference in income taxes and some income-tested programs given an individual s current and alternative investment and income portfolios. Common retiree situations are taken into account through a simplified tax calculation. It does not take all possible situations into account and may not be appropriate for every situation. The Clawback Calculator is not intended to replicate tax software but is rather a simplified calculation and may not create results identical to an individual s tax return. The calculator was based on current tax rates but may not reflect all current tax figures. Only credits with wide applicability to retirees, such as the age amount, pension income credit, medical expense credit and donations are included. There are many additional federal as well as provincial and territorial credits and benefits available that may be relevant to your client. If there is no place to input credit-related data such as Canada Pension Plan/Quebec Pension Plan (CPP/QPP) contributions, Employment Insurance premiums, disability or caregiver amounts, and education related amounts, that data is not taken into account by the calculator. Any references to age mean age on December 31 in the tax year being considered. If planning for 2015, for example, a client s attained age as of December 31, 2015 will be reflected in the illustration. For a complete listing of assumptions, click here. NOTE Enter client information in the applicable fields. Enter only positive numbers. Enter total annual amounts. There are fewer lines for input than on a tax return. Information on specific fields follows. 3 CLAWBACK CALCULATOR USER GUIDE

4 Fully taxable and investment income FULLY TAXABLE INCOME REGISTERED RETIREMENT INCOME Include all payments received from a RRIF, DPSP, locked-in plan, such as a LIF, and a registered annuity If any of these payments were being paid to a spouse or common-law partner and are now being received due to the death of that spouse or common-law partner, do not include them here; include them as pension income PENSION Include all amounts received from a company pension plan Also include any amount from a RRIF, DPSP, locked-in plan, such as a LIF, or registered annuity that were being paid to a spouse or common-law partner but are now being received due to the death of that spouse or common-law partner. For purposes of calculating tax credits, these payments will be treated as pension income PENSION INCOME TRANSFERRED FROM SPOUSE ( PENSION INCOME SPLITTING ) Spouses and common-law partners can complete one joint election form each year to transfer up to 50 per cent of qualified pension income to their spouse or common-law partner (the split-pension amount). This can result in a reduction of family taxes and can also minimize the impact on incometested tax credits and benefits The elected split-pension amount is deducted from the recipient s income and must be included in the income of their spouse or common-law partner OTHER INCOME Include income from other sources that doesn t appear to fit anywhere else. For example, lump-sum withdrawals from an RRSP, Employment Insurance benefits, disability income, Canadian rental income and foreign income. 4 CLAWBACK CALCULATOR USER GUIDE

5 INVESTMENT INCOME INTEREST INCOME Interest is fully taxable and includes income from bonds, GICs (issued by financial institutions including insurance companies), bank accounts, and interest reported from investment fund holdings For those age 65 or older, income received from a Guaranteed Interest Contract provided by a life insurance company will qualify as pension income NOTE If interest income from an insurance GIC is entered in this field, any pension income tax credit available on that income will not be reflected in this illustration. ELIGIBLE CANADIAN DIVIDENDS Dividends paid by Canadian public corporations qualify as eligible dividends and are grossed up so that 138 per cent of the dividend is included in taxable income. Non-eligible dividends may be paid by Canadian private corporations and are included at 118 per cent Dividends reported from investment fund holdings are considered to be dividends paid by a Canadian public corporation The non-refundable dividend tax credit (DTC) will reduce taxes so the overall tax payable on dividends from Canadian corporations is lower than on interest income NET CAPITAL GAINS The taxation of capital gains and losses is deferred until the asset is sold and any gain or loss is realized A capital gain is the profit that results from the sale or exchange of a capital asset, such as equities, bonds, mutual funds, segregated fund contracts, or real estate that exceed the cost of the asset. Only 50 per cent of the capital gain is included as taxable income A capital gain cannot be carried forward and must be declared in the year it is earned/realized A capital loss arises if the proceeds from the sale of a capital asset are less than the cost of the asset. Only 50 per cent of a capital loss can be used to reduce a capital gain A capital loss must be used against any capital gain realized that year and the excess, if any, may be carried back three years or carried forward indefinitely in order to reduce a taxable capital gain reported at that time SYSTEMATIC WITHDRAWALS FROM INVESTMENT FUNDS Include the full amount of all regular withdrawals from mutual funds and segregated fund contracts received in the year Only a small portion of the income stream is taxable as a capital gain; the balance will be non-taxable return of capital. The calculator assumes that the taxable percentage in year one is five per cent and there is no year-end allocation NON-REGISTERED ANNUITY INCOME Life annuities that qualify as prescribed annuities receive preferential tax treatment. For prescribed annuities, the taxable portion is based on age at purchase and remains constant for each payment For those over 65, the taxable portion of the income from an annuity will qualify for the pension income tax credit and pension income splitting 5 CLAWBACK CALCULATOR USER GUIDE

6 Deductions and expenditures DEDUCTIONS FROM INCOME REGISTERED RETIREMENT SAVINGS PLAN (RRSP) DEDUCTIONS RRSP contributions made in the year or within the first 60 days of the next calendar year can be deducted from income (up to the taxpayer s contribution limit) Contributions made after 1991 do not have to be deducted in the year the contribution is made. Deductions can be carried forward, even after age 71, to lower taxable income during retirement The last year a taxpayer can make a contribution, to his/her own RRSP, is the year he or she turns 71 For more details on RRSPs, see RRSP The Facts (MK1730) PENSION INCOME TRANSFERRED TO SPOUSE Spouses and common-law partners can complete one joint election form each year to transfer up to 50 per cent of qualified pension income to their spouse or common-law partner (the split-pension amount). This can result in a reduction of family taxes and can also minimize the impact on incometested tax credits and benefits The elected split-pension amount is deducted from the recipient s income and must be included in the income of their spouse or common-law partner For individuals age 65 or older, income from a pension plan and other registered income such as RRIFs, registered annuities, Deferred Profit Sharing Plan, locked-in plans such as LIFs and the interest reported on a Guaranteed Interest Contract from a life insurance company qualifies for pension income splitting Under age 65, only income received directly from a pension plan, or other registered income that was being paid to a spouse or common-law partner but is now being received as a result of the death of that spouse or common-law partner, qualifies for pension income splitting INTEREST AND CARRYING CHARGES Most interest paid on borrowed money can be deducted from income as long as the borrowed money was used to earn income from non-registered investments or from a business Fees to manage or administer non-registered investments can be deducted OTHER DEDUCTIONS Include other deductions or expenses that do not appear to fit anywhere else. This could include: Contributions to a pension plan Union and professional dues that were paid and not reimbursed Medical expense supplement 6 CLAWBACK CALCULATOR USER GUIDE

7 EXPENDITURES THAT GENERATE TAX CREDITS MEDICAL EXPENSES Total eligible medical expenses paid in a 12-month period that ends in the year of the tax return and that has not been claimed in the prior year may be claimed by either spouse or common-law partner. Eligible medical expenses include: Payments to a medical doctor, dentist, nurse, or certain other medical professionals, or to a public or licensed private hospital Premiums paid to private health insurance plans Payments for wheelchairs, crutches, hearing aids, prescription eyeglasses or contact lenses, dentures, pacemakers, prescription drugs, and certain prescription medical devices Travel expenses if required to travel more than 40 kilometres from home for medical treatment CHARITABLE DONATIONS To claim a tax credit for a donation, ensure that the organization has a Canada Revenue Agency (CRA) charitable registration number and can issue you a valid receipt The tax credit for donations above $200 is at a higher rate than on the first $200 of donations. Married and common-law couples can pool their donation receipts to maximize their tax credits A deduction for small amounts can be deferred and claimed on a tax return for any of the next five years when the total amount to be claimed will exceed $200 For more details see Charitable Giving The Facts (MK1485) 7 CLAWBACK CALCULATOR USER GUIDE

8 Current spendable income CURRENT TAX RATES MARGINAL TAX RATE This is the tax rate that applies to the last dollar of taxable income. As a taxpayer s income increases and he/she moves to a higher tax bracket, more taxes are paid on each additional dollar of income. EFFECTIVE TAX RATE This is the tax rate that a taxpayer would be taxed at if tax was calculated at a constant rate, instead of with graduated brackets. It is calculated as the total tax paid divided by the taxable income. Example of marginal and effective tax rates Consider the tax on $80,000 of taxable income MARGINAL TAX RATE EFFECTIVE TAX RATE TAX RATE TAX PAYABLE Taxable Income ($) Federal (%) Provincial (%) Combined (%) Federal ($) Provincial ($) Combined ($) First 38, ,700 1,900 7,600 Next 38, ,360 3,800 12,160 Next 4, , ,640 Total 80,000 A 15,100 6,300 21,400 B MARGINAL TAX RATE: 41% EFFECTIVE TAX RATE (B A) = 26.75% Assumptions Tax rates and brackets simplified for illustration purposes as follows: on the first $38,000 the tax rate is 20% (federal 15%; provincial 5%) on the next $38,000 the tax rate is 32% (federal 22%; provincial 10%) and on the balance the tax rate is 41% (federal 26%; provincial 15%) Tax calculation does not consider the effect of surtaxes or non-refundable tax credits. The marginal tax rate is 41% which is the tax rate that will be applied to the next dollar of taxable income. The effective tax rate is a 26.75% which reflects the total tax payable of $21,400 on $80,000 of taxable income. For illustration purposes only. 8 CLAWBACK CALCULATOR USER GUIDE

9 Restructuring investment income Investment income is included in taxable income at differing rates. If taxable income is too high, some income-tested tax credits and government benefits may be reduced or forfeited. Consider the impact of $10,000 of investment income from different types of investments Source of income Investment income ($) % Included on tax return $ Amount reported Eligible dividends from Canadian equities 1 10, ,800 Interest income from GIC/Bonds 10, ,000 Net capital gains from sale of capital assets 2 10, ,000 Non-registered annuity income 10, ,500 Systematic withdrawal from mutual funds or segregated fund contracts 10, Dividends paid by public corporations qualify as eligible dividends and are included at 138%. Non-eligible dividends are included at 118%. 2 Capital gains are included in income in the year they are realized. Capital losses can be used to reduce capital gains. 3 Taxable percentage for a prescribed life annuity approximated for a 65 year old female. The remaining portion is return of capital. 4 Taxable percentage in year one for $200,000 invested at a 5% annual return, no year end distributions or allocations, and a systematic withdrawal of $10,000. INTEREST INCOME Interest income is fully taxable For those age 65 or older, income received from a GIC provided by a life insurance company will qualify as pension income NOTE If interest income from an insurance GIC is entered in this field, any pension income tax credit available on that income will not be reflected in this illustration. ELIGIBLE CANADIAN DIVIDENDS Dividends paid by Canadian public corporations qualify as eligible dividends and are grossed up so that 138 per cent of the dividend is included in taxable income. Non-eligible dividends may be paid by Canadian private corporations and are included at 118 per cent Dividends reported from investment fund holdings are considered to be dividends paid by a Canadian public corporation The non-refundable dividend tax credit (DTC) will reduce taxes so the overall tax payable on dividends is lower than on interest income NOTE The grossed up dividends that are included in taxable income are used to determine eligibility for many income-tested benefits such as Old Age Security (OAS). If taxable income is too high, these benefits may be clawed back or forfeited. Canadian dividend income can be included in the income of either spouse in order to maximize the spouse or common-law partner credit and utilize the DTC 9 CLAWBACK CALCULATOR USER GUIDE

10 NET CAPITAL GAINS The taxation of capital gains and losses is deferred until the asset is sold and any gain or loss is realized A capital gain is the profit that results from the sale or exchange of a capital asset, such as equities, bonds, mutual fund, segregated fund contracts, or real estate that exceed the cost of the asset. Only 50 per cent of the capital gain is included as taxable income Systematic withdrawals from investment funds example of how to calculate the tax At the time of each withdrawal, there is a sale of units to fund the withdrawal. This sale will trigger a capital gain or loss. In order to determine the amount of the capital gain or loss one must look at the Adjusted Cost Base (ACB) and the growth/loss (Fair Market Value ACB) A capital gain cannot be carried forward and must be declared in the year it is earned/realized A capital loss arises if the proceeds from the sale of a capital asset are less than the cost of the asset. Only 50 per cent of a capital loss can be used to reduce a capital gain A capital loss must be used against any capital gain realized that year and the excess, if any, may be carried back three years or carried forward indefinitely in order to reduce a taxable capital gain reported at that time $10,000 GROWTH AT 5% DEPOSIT OF $200,000 Systematic Withdrawal $10,000 Capital Gain ($10,000/$210,000) Taxable Return of Capital ($200,000/$210,000) Not Taxable SYSTEMATIC WITHDRAWALS FROM INVESTMENT FUNDS Receiving regular withdrawals from mutual funds and segregated fund contracts is tax-efficient since only a small portion of the income stream is taxable as a capital gain; the balance will be non-taxable return of capital For more details see Tax treatment of Systematic Withdrawal Plans (SWPs) (MK2329) This diagram illustrates the formula to be used. In this example, the growth represents 1/21 ($10,000/$210,000) of the total Fair Market Value (FMV). 1/21 of each dollar realized as a result of a redemption will be considered a capital gain. The return of capital represents 20/21 ($200,000/$210,000) of the total FMV. This is not taxable but does reduce the ACB. The calculation will depend on the growth/loss and the ACB at the time of withdrawal. Note In addition to capital gain/loss generated by the sale of units, any reported allocation/distribution of capital gain, interest or dividends from the investment fund holdings should be entered in the appropriate investment income field. NOTE In a down market, systematic withdrawals from an investment fund will generally erode capital. NON-REGISTERED ANNUITY INCOME Life annuities that qualify as prescribed annuities receive preferential tax treatment. The taxable portion is based on age at purchase and remains constant for each payment For those over 65, the taxable portion of the income from an annuity will qualify for the pension income tax credit and pension income splitting 10 CLAWBACK CALCULATOR USER GUIDE

11 Assumptions To reflect most taxpayer situations, the following simplifying assumptions were made: Individuals are age 18 or older There is sufficient net income so that there is no transfer of eligible amounts between spouses or dependants There are no eligible or infirm dependants There are no dependent children Canada/Quebec Pension Plan (CPP/QPP) contributions and Employment Insurance (EI) premiums are not applicable Alternative minimum tax does not apply All net capital gains are 50 per cent taxable (there are no charitable donations eligible for zero per cent taxable treatment) There are no charitable donations beyond 75 per cent of net income that are eligible for credit For prescribed annuity contracts the rates are based on female life expectancy Dividend income is eligible dividends received from a public Canadian corporation The pension income tax credit available on income from an insurance GIC will not be reflected in this illustration For systematic withdrawals from investment funds, the taxable percentage in year one is assumed to be five per cent and there is no year-end allocation 11 CLAWBACK CALCULATOR USER GUIDE

12 ASSUMPTIONS REGARDING NON-REFUNDABLE CREDITS Only selected credits with wide applicability to retirees are included. Additional federal as well as provincial and territorial credits and benefits may be available. Tax credits are calculated at the lowest federal and provincial/territorial tax rates. For residents of Quebec the middle tax rate of 20 per cent is used for the provincial tax credits. The maximum amounts of the non-refundable tax credits are presented in the illustration results and summary. Where an individual does not have sufficient taxable income and tax payable, they may not be able to utilize the full amount of these credits. The following non-refundable tax credits are reflected in the illustration as described. Basic personal amount a federal and provincial/ territorial non-refundable tax credit is available to all residents of Canada. For illustration purposes, this credit is calculated at the lowest tax rate and is reflected in the calculation of federal and provincial/ territorial income taxes. Age amount a non-refundable tax credit is available for individuals who have attained age 65 by the end of the year. This credit is income-tested and is reduced for individuals with net income in excess of $35,466 in Individuals with income above $82,353 will not receive an age credit. For illustration purposes, the provincial/territorial age credit is assumed to be at the federal amount and threshold (actual credit varies by province/territory). Pension income amount a federal non-refundable tax credit is available on the first $2,000 of qualified pension income. A provincial/territorial pension income credit is also available. For illustration purposes, the provincial/territorial pension income level for the credit is assumed to be $1,000 (actual amount varies by province/territory). Canada employment amount a federal non-refundable tax credit is available to all employees who have income from employment in Canada. Income from self-employment is not eligible for this credit. Medical expenses a federal non-refundable tax credit can be claimed for eligible medical expenses in excess of the lesser of three per cent of net income and a threshold amount ($2,208 in 2015). For illustration purposes, the federal threshold amount is used for the provincial/territorial medical expense credit. Charitable donations a federal and provincial/ territorial non-refundable tax credit can be claimed for charitable donations up to 75 per cent of net income. For illustration purposes, increased limits applicable to donations of capital property and in the year of death are not reflected in this calculator. Many additional federal as well as provincial and territorial credits and benefits are available that may be relevant. If there is no place to input credit-related data such as CPP/QPP contributions, EI premiums, disability or caregiver amounts, and education related amounts, that situation is not taken into account by the calculator. 12 CLAWBACK CALCULATOR USER GUIDE

13 ASSUMPTIONS REGARDING NON-REFUNDABLE DIVIDEND TAX CREDIT Taxes payable can be reduced by a dividend tax credit (DTC) that is available for dividends received from Canadian corporations. Foreign dividends do not qualify for this credit. The illustration assumes that dividends are eligible dividends received from Canadian public corporations and reflects the federal DTC at per cent of the taxable amount of dividends received. The provincial/territorial DTC is assumed at eight per cent of the taxable amount of eligible dividends received (actual varies by province/territory). The maximum amount of the non-refundable dividend tax credit is presented in the illustration results and summary. Where an individual does not have sufficient taxable income and tax payable, they may not be able to utilize the full amount of this credit. The illustration does not reflect the lower federal and provincial/territorial amount of the DTC for non-eligible dividends received from Canadian private corporations. A taxpayer may claim the DTC of their spouse or common-law partner where the underlying dividend income is transferred to the taxpayer. 13 CLAWBACK CALCULATOR USER GUIDE

14 This calculator does not take into account all Canadian tax rules. Values are in Canadian dollars. The Clawback Calculator and all output it provides is for general information only and should not be considered investment or tax advice to any party. The calculator is intended to be used for planning purposes only. It does not include every available tax credit. We cannot guarantee the results. The calculator is not intended to replicate tax software but is a simplified calculation that may not create the results identical to a client s tax return. It does not take all possible client situations into account and may not be appropriate for all client situations. The results are based on the information and assumptions provided and are for illustrative purposes only. This report is for information purposes only and is not intended to provide specific financial, tax, legal, accounting or other advice and should not be relied upon in that regard. Individuals should not act or rely on this information without seeking the advice of a professional in order to ensure that any action taken with respect to this information is appropriate to their specific situation. Any personal information you have provided to generate this report is governed by Manulife s Privacy Policy which you can access at Manulife, the Block Design, the Four Cubes Design and strong reliable trustworthy foward-thinking are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under licence. CS2125E 04/2015