The federal government, in its budget announcements last year, increased the pension income amount, doubling the maximum amount of eligible pension income that can be used to calculate the credit to $2,000.
The following will help you understand the pension income amount and the potential tax planning strategies available.
The pension income amount is used to calculate the pension income credit. In 2006, you are entitled to a Federal tax credit of 15.25 per cent of the pension income amount (up to a maximum of $2,000).
The Canada Revenue Agency website (www.cra-arc.gc.ca) provides some useful tools to assess whether you can take advantage of the pension income amount. The first thing to check is your prior year tax return, determine if you have reported pension or annuity income. Important note: Old Age Security, Canada Pension Plan, death benefits, and retiring allowances do not qualify for the pension income amount.
The second item to note is that pension income is calculated differently depending on your age. Individuals who are younger than 65, generally are not eligible for the pension income amount. The two main exceptions for individuals younger than age 65 include: payments from a Registered Pension Plan (provided they are life annuity and not lump sum payments) and annuity payments arising from the death of your spouse under a Registered Retirement Savings Plan (RRSP), Registered Retirement Income Fund (RRIF), Deferred Profit Sharing Plan (DPSP) and other specified plans.
Are you 65 or older?
If you are at least 65, then the following represents some of the main types of pension income that may be considered: annuity payment out of a RPP, RRSP or a DPSP; payment out of a RRIF; interest component from a prescribed annuity; or accrual income included in respect of non-exempt life insurance policies and non-prescribed annuities.
To get the maximum pension credit, your goal should be to have at least $2,000 of pension income for both you and your spouse (assuming your spouse is also at least 65 years old). The following are a few strategies to consider:
Strategy 1: If your spouse does not have a pension then you should consider creating one for them at age 65. The 2007 Federal Budget announcement proposes to extend the RRSP conversion age from 69 to 71. If you are older than 71 but your spouse is younger than 71, you may be able to create pension income. This can be achieved by opening a spousal RRSP and making a contribution to the plan. This assumes that you are able to utilize the RRSP contribution deduction and you have RRSP carry forward room. When this income is withdrawn as an annuity payment, the pension income created may be eligible for the pension income amount (up to $2,000 annually).
Strategy 2: Although there are restrictions that may apply, if your spouse has eligible pension income but is not able to utilize the pension credit because their tax payable has been reduced to nil by using other tax credits, you should transfer the unused portion of their pension income credit to you.
Strategy 3: If you do not have any qualifying pension income, are age 65 or over, and do not want to draw down your registered assets at this time, you could consider purchasing a non-registered Guaranteed Income Annuity (GIA) from a life insurance company. Note: this is very similar to a Guaranteed Investment Certificate (GIC). The deposit should be enough to produce $2,000 of interest income and this income will qualify for the pension income amount. The reporting of the income is done on a “policy year” basis rather than “calendar year,” so it is important to determined the best time to purchase these.
Strategy 4: Roll a portion of your RRSP to a RRIF at age 65. If your RRSP is $200,000 then you may want to consider transferring $50,000 of this amount to a RRIF at age 65 (see chart below) and keeping the remaining $150,000 in your RRSP. The following chart outlines possible transfer amounts from an RRSP to RRIF that may create $2,000 of pension income in the first year:
Age (Per Cent) ($)
65 4.00 $50,000
66 4.17 $47,962
67 4.35 $45,977
68 4.55 $43,956
Strategy 5: Individuals without a registered account may want to consider purchasing an annuity. Annuities purchased outside of an RRSP are taxed on the prescribed basis. This means that a portion of the annuity income payment is considered a return of capital and the remainder is interest income. The annuity purchase should be sufficient to produce $2,000 of interest income annually.
Strategy 6: Individuals that are 65 years old with an RRSP may want to consider transferring a portion of their RRSP into an annuity. Annuities purchased with funds from a registered account create an income stream that is fully taxable. As a result a smaller amount from a registered account (compared to a non-registered account) would enable people to fully utilize the pension income amount.
Strategy 7: As noted above, the Federal Budget proposes to extend the RRSP conversion age from 69 to 71. Individuals converting their RRSP to a RRIF at age 71 are not required to make a minimum payment in that first year. It may be prudent for some individuals to make a $2,000 withdrawal during the first year to utilize the pension income amount.
Individuals who have not reached the pension age yet may still find the above advantageous for planning purposes. Others between ages 65 and 71 should determine if their household is fully utilizing the pension income amount. Some households may find that they are able to offset up to $28,000 of income with the pension income amount over a seven-year period.
Before implementing any strategies discussed in our columns we recommend that you speak with your professional advisors.