How Retirement Benefit Clawbacks Hit Lower-Income Taxpayers Hardest

To: Finance Canada
From: Nick Dahir and Alexandre Laurin
Date: February 6, 2026
Re: How Retirement Benefit Clawbacks Hit Lower-Income Taxpayers Hardest

The taxation of retirement income is a key consideration for pension, tax, and fiscal policy.

Drawdowns of tax-deferred retirement savings are taxable. Future government revenues depend on how withdrawals are taxed in retirement, and government spending depends on how this retirement income affects eligibility for cash benefits. Benefit reductions, in particular, may act as a penalty on private retirement saving.

In our C.D. Howe Institute Commentary, we focus on the taxation of income after age 65, when individuals become eligible for age-related benefits.

A common pattern across all provinces emerges: Marginal effective tax rates, inclusive of income-tested clawbacks of government benefits, are extremely high at lower levels of retirement income (see Figure). Seniors who work may be discouraged from increasing their hours. Those who do not work may decide not to take on a job at all, or to accept lower-paying work.

METRs for Seniors

Marginal effective tax rates (METRs) for seniors reflect the loss associated with each additional dollar of income due to higher taxes and reduced cash benefits. Because programs such as Old Age Security (OAS) and the Guaranteed Income Supplement (GIS) provide a basic income floor, benefits are clawed back as income rises, resulting in high METRs from the first dollar of taxable retirement income.

Low-income seniors face the highest effective tax rates, which decline as income rises. The primary driver is the phase-out of the GIS. For single seniors drawing pension income (including CPP/QPP), GIS is reduced by:

• 50 cents per dollar from $0 to about $2,000;
• 75 cents per dollar from about $2,000 to $10,000;
• 50 cents per dollar from $10,000 to about $22,000.

Seniors earning employment income benefit from partial exemptions:

• The first $5,000 of employment income is fully exempt from GIS clawbacks;
• The next $10,000 is subject to only half the normal clawback rate.

Despite these exemptions, overlapping federal and provincial benefit reductions can produce METRs exceeding 75 percent and, in some provinces, even exceeding 100 percent over narrow income ranges.

We estimated that as many as 42 percent of single seniors receiving pension income face METRs above 50 percent. The share of seniors facing high effective tax rates has increased over time, largely due to enhancements to the GIS and associated clawback rates.

Participation Tax Rates for Seniors Who Work

Participation tax rates (PTRs) measure how much total employment income is lost to taxes and reduced benefits when a senior chooses to work.

For seniors eligible for GIS and OAS, high PTRs may discourage labour-force participation. PTRs are lower at modest employment income levels due to GIS exemptions, but rise sharply once those exemptions are exhausted.

We calculated that a single senior drawing average CPP income and considering complementing it with a job earning half of the average yearly industrial wage would face an average participation tax rate of nearly 50 percent.

Policy Implications

Government budgets are limited, and income-testing new benefit programs enables higher base benefits for targeted groups by reducing overall fiscal costs. However, federal and provincial governments should be careful not to layer multiple income-tested benefit programs on top of one another, as clawback rates can add up to create excessive effective tax rates at lower-income levels (see Figure).

Income testing of multiple government benefits requires an integrated approach to benefit reduction rates. When introducing or expanding income-tested programs, policymakers should be mindful of the added economic and fiscal costs associated with clawbacks and balance these against the social benefits of targeting.

For example, while the existing federal GIS provides higher benefits to low-income seniors, it also creates economic and fiscal costs through negative effects on work incentives. Policymakers should consider expanding the earnings exemption to further reduce work disincentives among seniors.

Nick Dahir is a Research Officer at the C.D. Howe Institute where Alexandre Laurin is Vice-President and Director of Research.

To send a comment or leave feedback, email us at blog@cdhowe.org.

The views expressed here are those of the authors. The C.D. Howe Institute does not take corporate positions on policy matters.

Want more insights like this? Subscribe to our newsletter for the latest research and expert commentary.