Get used to the term pension splitting. We’ve been hearing a lot lately about this part of the proposed Tax Fairness Plan unveiled lat October by federal Finance Minister Jim Flaherty, which is designed to save taxes by transferring pension income from the hands of one spouse or common-law partner in a higher marginal tax bracket to the hands of the other spouse in a lower tax bracket.
Pension income splitting is primarily referring to couples receiving pension income. Many single individuals and widows have frowned upon the plan for this reason.
The main reason for splitting pension income is to reduce the household tax bill. But there are other issues that go beyond tax savings. Many social benefits are income tested and reducing income may assist the higher income spouse to obtain more benefits by splitting pension income.
A good example of this is the Old Age Security (OAS) claw-back – when income exceeds $64,511 pensioners must repay part of their OAS. Transferring income over this threshold to the lower income spouse may assist the higher income spouse in receiving more OAS.
Another example relates to the pension income amount ($2,000 annually). If the lower income spouse does not already have pension income then transferring pension income to the lower income spouse will enable both to qualify for the pension income amount.
Individuals may be permitted to allocate up to one-half of their pension income to their spouse or common-law partner. It is important to define for splitting purposes what “pension income” is eligible. The following is a list of eligible income that may be split (taken directly from the Department of Finance website: www.fin.gc.ca):
- Income in the form of a pension from a registered pension plan (RPP), regardless of the recipient’s age (i.e., a pension from an employer-sponsored defined benefit plan or defined contribution plan).
- Income from a registered retirement savings plan (RRSP) annuity, a registered retirement income fund (RRIF), a LIF (a locked-in RRIF), or a deferred profit sharing plan (DPSP) annuity, if the recipient is 65 years of age or older.
Income that is ineligible includes
- Old Age Security (OAS)
- Guaranteed Income Supplement (GIS)
- Canada Pension Plan (CPP) / Quebec Pension Plan
- RRSP annuities, RRIFs, and DPSP annuities (if recipient is under age 65)
- RRSP withdrawals
- Income from retirement compensation arrangements (RCAs)
Noted above is that CPP income does not qualify as eligible pension income for splitting under the Tax Fairness Plan. Existing rules already permit spouses and common-law partners to share CPP provided both are at least 60 years of age, collecting CPP and have submitted the appropriate forms.
The Department of Finance website also has a “Senior’s Tax Savings Calculator”. It provides an estimate of the federal income tax savings but may not provide an estimate of the combined effect on taxes and all benefits. The online calculator can be a useful tool for planning purposes but should never be substituted for professional advice from a qualified accountant. There are many factors which should be considered before automatically splitting your income, including age, income levels, medical expenses, disability, current thresholds for Old Age Security, current thresholds for the Age Credit; whether the pension income amount ($2,000 annually) is currently being utilized by both spouses; and registered account balances
Some decisions to split pension income could have a negative outcome. Using Mr. and Mrs. Irvine as an example, they earn $110,000 and $60,000 of pension income (primarily RRIF payments) respectively. If the higher income spouse transfers $25,000 of pension income then both incomes will be $85,000. Although they may save a little in taxes, the OAS clawback will likely exceed the tax savings. We emphasize that it is important to look at all government benefits, credits, pension amounts and components that are unique to your tax situation.
If the proposed income splitting is approved for 2007 then it is likely that you and your spouse will not need to make a decision until April 2008, when it is time to file your personal income tax returns for 2007. At that time, the spouse with the highest income can allocate up to 50 per cent of their income to be taxed in the hands of the lower-earning spouse. Your accountant will be able to prepare an analysis to determine the optimal amount of pension income to split with your spouse. The result may be an increase in taxes payable for the lower income spouse and a decrease in the taxes payable for the higher income spouse. One would only proceed with this if the combined tax liability is reduced. If the legislation is passed and the tax liability is reduced, then both you and your spouse must jointly agree to the allocation by making an election in your 2007 tax return prior to April 2008. This election would be required on an annual basis.