Financial Crooks

A few months ago I pompously dismissed the suggestion that you can buy a stock the day before the dividend is earned and sell the day after without ever testing the idea. Recently I ran a test.

How I Got Suckered

I made the mistake of looking at the ex-dividend dates of several reliable, high paying, blue chip stocks at the same time. They were all spaced 5 or more days apart. So in theory, you could buy one stock, hold till it went ex-dividend, sell, buy the next, rinse and repeat. You could invest the same money about 4 times in one month and pick up 4 quarterly dividends ranging from 3.5%-5%. Sounds cool right?

Now of course the price for a stock will drop by the same amount as the dividend payment as soon as it goes ex-dividend. But these stocks, though blue chip, are highly traded. You could see that historically they bounced around more on a weekly basis than the amount of the dividend.

So they should bounce right back up in price, right?

(Sucker!)

Where I Went Right

I chose to make the test using BCE. Ma Bell pays a dividend of over 5% and is a strong large blue chip company. (So was Nortel.) If the market was to collapse tomorrow, BCE would probably recover within 5 years, which is before I need the money from the test account.

Where I Went Wrong

I got greedy. I bet the farm, the wood lot, the mineral rights, and the guinea pigs.
Instead of running the test with one share or even one hundred shares, I bet 1035 shares.
Between the two sales commissions and the fact you’d only get a quarterly dividend it didn’t seem practical to invest a small amount for the test.

And yes, I could have just kept track of the stock price on paper. In fact, that’s what I really did. Honest. I didn’t try to juggle acetone peroxide detonators with my bare hands. What’s that? Oh I’ve always been short a finger on that hand.

So when the shares tanked I had no cash to play with in the account. If a harsh market correction had occurred, if I’d had a good chunk of cash, I could have bought shares in defensive stocks (or a low MER full-market ETF) and as it rose in value again, I would have had something to counterbalance the massively overpriced BCE shares.

Like many people who lost their savings when bubbles popped, however, by buying all at once near the top, I risked having to try to hang tight for years with no profit hoping for a rebound. Not a way to sleep comfortably at night—for years.

Where I Got Lucky

It is purely luck that the stock market headed the direction it did and within two months brought the BCE share price back up to the price at which I made the purchase. If I had bought these shares in say early 2008, I could have had a very long wait to see the numbers flip back into the green on my investment.

Remember, people in 2008 didn’t see the market crash coming either. It’s like when a transport crosses the grassy median between the lanes on the 401 on a foggy morning: You can’t see a market collapse coming before you’re staring into the headlights of a big rig coming straight at you out of the gloom at 110 km/h.

I was very lucky. Like Lucy, I nearly had some s‘plainin’ to do to my husband. (I did confess, of course, already. What can I say? He plied me with chocolate.)

Unfortunately, most of us are not lucky all the time. Or even more than half the time. (I do know some people who are unlucky more than half the time, though.) I don’t think I’ll push my luck and try this ever again. Even if BMO is about to go ex-dividend April 29…..

What Happened to the Share Price?

I bought on March 10.
On March 12 BCE went ex-dividend.
Then it began to plummet.
On April 2, I gave up and sold half of my position for an overall profit but at a price per share lower than I had paid for the stock. (e.g. the dividend for those shares would offset the capital loss)
On April 15 the stock returned, very briefly, to the price I had purchased it at.
On April 16, I received the dividend payment.
On April 17, the stock climbed enough above the purchase price to sell the rest of my position and break even on the capital cost plus the trading commissions. I ended up with a total event capital gain of $0.20 and the entire dividend.

Was It Worth the Stress for Over a Month?

No. There are much calmer ways to make $600. Like working as a pothole repair person on the 401 in the middle lanes near Toronto.

Is Any of This True?

Right now you may be wondering whether this article was posted on April 1.

All I’ll say is it should have been.

Related Reading

Can You Buy a Stock Before the Dividend Is Payable Then Sell It Immediately Afterward?

Join In
Have you ever invested way too much in one stock only to live the life for the next few weeks of the 12-cups-a-morning caffeine addict who can’t get anything stronger than a cup of herbal tea? Please share your words of financial hindsight wisdom with a comment.

A relative was recently trying to evaluate the impact on her OAS payments if she sold a cottage. She may need the money soon to pay for accommodations in a long term care facility, though touch wood maybe not. Either way, she wasn’t sure how much impact the sale would have on her OAS and for how many years. She purchased the land and built the cottage in the 1970s. She used the opportunity when the government phased out the lifetime $100 000 personal capital gains exemption in 1994 to bring the adjusted cost base of the cottage up to the highest possible; The cottage is still worth more though. I decided to help her find out what will happen to her OAS if she sells the cottage for a large capital gain.

The whole exercise may be a bit academic, however. There are many cottages on that lake that have been listed for sale for several years with no offers!

What Is the OAS Pension Recovery Tax?

Canadian Old Age Security payments are subject to a “pension recovery tax” (according to the CRA) or a “clawback” (according to everyone else.)

If a person receiving OAS in 2013 had income of $70 954 or higher then they will have to pay back some of their OAS payments when they file their 2013 taxes. (If their income was $114 815 or higher they will have to pay back all of their OAS.)

How Do Capital Gains Trigger the OAS Clawback?

Many types of capital gains are added to your total and taxable income.

For example, if you sell stocks for $10 000 more than you purchased them for (after costs and fees) you will have a capital gain of $10 000 of which $5 000 is taxable. You report your total capital gains using Schedule 3 and report the taxable capital gains on line 127 of the second page of your T1.

Selling a property like a cottage which is not your primary residence also could result in a capital gain. In my relative’s case, if she sold her cottage she would probably make a total capital gain of about $50 000. That would add 50% x (50 000) or $25 000 to her total income for the year of the sale.

If that $25 000 of additional income moves her above the $70 954 threshold, then she will have to pay back some of her OAS for that year.

How Much OAS Will I Forfeit Because of my Capital Gain?

If your capital gain moves your income above the threshold you will have to pay back some of your OAS.

If you want to calculate how much, Service Canada suggests you can estimate it using the following method.

Subtract the threshold income from your actual income.
Multiply the answer by 15%.

That is an estimate of the amount that must be repaid.

For example, if my relative had an income of $75 000 in 2013 due to the capital gain, she would calculate:
$75 000 – $70 954 = $4 046
(15/100) x ($4 046) = $606.90
The estimated OAS social benefits repayment is $606.90.

To calculate the actual repayment amount, you must complete the T1 General Federal Worksheet for the tax year in question. [When I did this for my test case I got exactly the same answer for the OAS clawback.]

The repayment amount should be reported on your income tax return on Line 235 and on Line 422. Line 235 is used to remove the amount that is clawed back from your income before you calculate how much income tax you need to pay. (Otherwise you’d be paying income tax on the money that you didn’t get to keep.) Line 422 adds the amount of OAS you need to repay to the amount of taxes you need to pay.

How Many Years of OAS Will Be Lost Following a Large Taxable Capital Gain?

My relative had heard that having to pay back some OAS one year would result in lower OAS payments the next year. She was fuzzy about how that drop in OAS payments worked.

I checked on the Canada Revenue Agency website for the details.

If a person has a one-time large capital gain, they may have to pay back some of the OAS they received during that same tax year.

The next year, their income will drop back to normal and they should not forfeit any of their OAS pension.

So only one year of OAS is permanently affected by a large capital gain. You would forfeit some or all of your OAS if the capital gain is large enough to push you above the threshold income. In 2013 that income was $70 954.

What Happens to Your OAS in the Year after the Large Capital Gain?

However there’s a catch. The government bases its OAS monthly payments on a person’s income the previous year. If the income that previous year was high enough to require OAS repayments, then they will start withholding some of the OAS payment each month of the following year.

It’s similar to the way the government withholds some of your income from your pay cheque for your income tax payment if you have a reasonably well paying job.

If you had a one time capital gain, however, you won’t have a higher income the following year. You should not have to have any OAS withheld because you won’t need to repay any of the OAS when you file your taxes. What can you do to prevent them from withholding some of your cheque?

How Can I Prevent Service Canada from Withholding Some of My OAS Monthly Cheque?

There’s a form for that!

It’s called the T1213(OAS) Request to Reduce Old Age Security Recovery Tax at Source for Year ____ .

The form is available on the Canada Revenue Agency website at http://www.cra-arc.gc.ca/E/pbg/tf/t1213_oas/README.html .

You can use this form only if you have filed all of your tax returns and paid any taxes due.

The completed form should be sent to the Taxpayer Services Division for your area. There are instructions on the form (including a toll-free phone number) to find out that address.

What Do I Need to Fill Out the T1213 (OAS) Request to Reduce Old Age Security Recovery Tax Form?

This is a simple one page form but there are quite a few numbers to fill out. You can get most of them from your previous year’s tax return provided you expect your income from various sources to stay about the same.

The information you need to complete the form is:
Estimated Income (for the upcoming year)

employment income
OAS
CPP or QPP
other pensions and superannuation
dividends
interest and other investment income
rental income
RRSP or RIF income
other income

Deductions

carrying charges and interest expenses
other deductions

Non-refundable Tax Credits

disability amount
medical expenses
charitable donations

Refundable Tax Credits

income tax deducted for this upcoming year
tax installments already paid for this year

Identification Information

Name
address
telephone number
Social Insurance Number

You also have to sign the form.

How Long Will It Take to Know If the CRA Has Agreed to Not Withhold Tax from my OAS Cheque?

According to the information on the T1213 (OAS) form, it takes 4-6 weeks for the government to make a decision about whether or not to stop withholding tax from your OAS monthly payments. They say you will be advised in writing by mail.

If I Forget to File the Form Will I Ever Get My OAS Back?

Yes and yes.

If the government withholds some of your OAS monthly payment even though you are not making enough income to have to repay any OAS, you will eventually get the money back. When you file your tax return in April, you will report how much OAS they withheld. You report this withholding on Line 437 of your tax return. (Your T4-OAS will tell you how much was withheld.) Since this will be more than you owe in taxes, you will get a tax refund for the withheld amount.

Also, in the second year after you received the large capital gain, your OAS payments should return to their original level. The government will look at your income for the year after the capital gain, see that it is lower, and stop withholding any portion of your OAS monthly payment.

According to the Tax Planning Guide http://www.taxplanningguide.ca/tax-planning-guide/section-2-individuals/old-age-security-oas-clawback/ if they withheld too much OAS, you will either receive a refund or the amount will be used to reduce the tax you owe on other income.

So eventually the waters will calm.

OAS Withholding Is Not Based on Calendar Years

In the above article, I’ve simplified everything as if Service Canada does its math based on calendar years. In fact it does not, unfortunately.

Say your income in 2013 was $75 000 which is above the threshold for 2013 of $70 954. Service Canada will use this $606.90 repayment requirement to reduce your future OAS payments so that you will not have to pay a large chunk of money all at once when you file your taxes in April.

Because the CRA will not know your 2013 income until you file your taxes by April 30 of 2014 there is a delay in when Service Canada can start withholding some of your OAS payment.

So Service Canada reduces how much OAS you receive monthly from July 2014 – June 2015 based on your 2013 taxes filed by April 30, 2014.

For a situation where your income has spiked up for only one year, it’s a good idea to file the T1213(OAS) form and not have them withhold any of your OAS cheque.

What Happens If I Don’t Live In Canada and I Have to Repay My OAS?

There are details about the OAS recovery tax for people living outside of Canada on the Service Canada website at http://www.servicecanada.gc.ca/eng/services/pensions/oas/pension/recovery-tax.shtml.