Lower Your Tax Bill By Sharing Your Pension

Pension income splitting is a significant aspect of retirement planning in Canada. This strategy allows couples to effectively lower their total tax bill by transferring a portion of the higher income individual's pension income to the lower income partner. This glossary article aims to provide an in-depth understanding of pension income splitting, its benefits, eligibility criteria, and how it impacts retirement planning in Canada.

Understanding the concept of pension income splitting is crucial for effective retirement planning. It can significantly influence the amount of tax you pay and, consequently, the amount of income you have available during your retirement years. This article will delve into the intricacies of pension income splitting, providing a comprehensive guide to this essential retirement planning strategy.

Understanding Pension Income Splitting

Pension income splitting is a tax-saving strategy that allows a higher-income spouse or common-law partner to transfer up to 50% of their eligible pension income to their lower-income partner. This strategy is designed to take advantage of the progressive nature of Canada's tax system, where higher income is taxed at higher rates.

By transferring a portion of pension income from the higher-income spouse to the lower-income spouse, the couple's total tax liability can be reduced. This is because the transferred income will be taxed at the lower-income spouse's lower tax rate, rather than the higher-income spouse's higher tax rate.

Eligible Pension Income

Not all types of pension income are eligible for income splitting. In Canada, eligible pension income depends on the age of the pensioner. For those under age 65, eligible pension income includes lifetime annuity payments from a superannuation or pension fund and payments from a Registered Retirement Income Fund (RRIF).

For those aged 65 and over, eligible pension income also includes annuity payments from a Registered Retirement Savings Plan (RRSP), payments from a RRIF, and certain other types of income. It's important to note that Old Age Security (OAS) and Canada Pension Plan (CPP) payments are not eligible for pension income splitting.

Benefits of Pension Income Splitting

Pension income splitting can provide several benefits. The primary benefit is the potential for significant tax savings. By shifting income from a higher tax bracket to a lower one, couples can reduce their overall tax liability. This can result in more income being available during retirement.

Another benefit of pension income splitting is that it can help to preserve income-tested benefits. By reducing the higher-income spouse's net income, it may be possible to reduce or eliminate clawbacks on income-tested benefits such as the Old Age Security (OAS) pension.

How Pension Income Splitting Works

Implementing pension income splitting involves several steps. First, the higher-income spouse or common-law partner must receive eligible pension income. Next, the couple must make a joint election to split the pension income by completing Form T1032, Joint Election to Split Pension Income.

The amount of pension income that can be split is determined on a yearly basis. The couple can choose to split any amount up to 50% of the eligible pension income. Once the election is made, it cannot be changed or cancelled after the deadline for filing the tax return for that year.

Impact on Tax Credits and Deductions

Pension income splitting can also impact various tax credits and deductions. For example, the pension income amount used for the pension income splitting can still be claimed for the pension income amount tax credit. However, the higher-income spouse or common-law partner must claim the credit.

Similarly, the age amount tax credit is calculated based on the net income after the pension income splitting. This means that if the higher-income spouse's net income is reduced due to pension income splitting, they may be able to claim a higher age amount tax credit.

Effect on Income-Tested Benefits

As mentioned earlier, pension income splitting can help to preserve income-tested benefits. This is because the income transferred to the lower-income spouse is not included in the net income calculation for the higher-income spouse for the purposes of income-tested benefits.

For example, the Old Age Security (OAS) pension is subject to a recovery tax, also known as a clawback, when net income exceeds a certain threshold. By reducing the higher-income spouse's net income through pension income splitting, it may be possible to reduce or eliminate the OAS clawback.

Considerations and Limitations

While pension income splitting can provide significant benefits, it's important to consider some potential limitations and drawbacks. One key consideration is that the lower-income spouse must include the split pension income in their income and pay tax on it. Therefore, it's important to consider the lower-income spouse's tax bracket when deciding how much pension income to split.

Another consideration is that pension income splitting is not available to single individuals or to couples where only one partner has eligible pension income. Furthermore, the decision to split pension income is made on a yearly basis and cannot be changed after the deadline for filing the tax return for that year.

Professional Advice

Pension income splitting can be a complex strategy, and it's important to seek professional advice before implementing it. A financial advisor or tax professional can help you understand the potential benefits and drawbacks of pension income splitting based on your specific circumstances.

They can also help you navigate the tax implications of pension income splitting and ensure that you comply with all relevant tax laws and regulations. This can help you maximize your tax savings and ensure that you have a comfortable and financially secure retirement.