As boomers and seniors start to receive retirement income from pensions and other sources, it will be time to get to know the ins and outs of pension income-splitting.
A spouse or common-law partner is allowed to allocate up to 50% of eligible pension income to the lower-earning spouse. This benefits couples if one spouse is in a different tax bracket from the other.
Allowing the higher-income spouse to shift income to the other spouse results in overall tax savings. "Canada has a progressive tax system, meaning as our income levels rise, so do our tax rates on that income," says Frank DiPietro, director of tax and estate planning at Mackenzie Investments. "Income-splitting provides a way of easing the burden."
Participating in income-splitting doesn't mean the couple must divide how they receive their pension proceeds. Instead, the income-splitting calculation and reporting is completed directly on the tax return.
Here's how it works. Let's say Bill is 75 years old and receives $25,000 from his registered retirement income fund (RRIF) this year. Bill would report that amount as income on his tax return. Then Bill and his wife Marianne would fill out a joint election form that declares how much of that $25,000 they intend to split. If it's half the income, or $12,500, Bill gets a $12,500 tax deduction while Marianne reports $12,500 as income on her tax return.
Most seniors know about pension income-splitting, since it was launched seven years ago, says Leony deGraaf, a certified financial planner at Burlington, Ont.-based deGraaf Financial Strategies. That said, some new clients have never had an advisor examine their tax returns and notices of assessment to determine the benefit of splitting. "Let's face it, financial planning really does start and end with taxes," deGraaf says. "Without this information, you are missing a big piece of the puzzle."
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For that reason, Mackenzie's DiPietro recommends working with a tax professional to determine how much income it makes sense to shift to a spouse. He also notes that with most professional tax software, optimization calculations can be made to determine precisely how much income to shift to the spouse to get the maximum benefit. "Although the rules allow you to shift up to 50%, it doesn't mean you have to shift 50%," he says. "It could be less. It depends on everyone's situation and how much each person is earning."
One of deGraaf's strategies is to ensure her retired couples are in the most advantageous tax brackets. For instance, if Bill has $75,000 of eligible pension income, he's in the 33% tax bracket. Marianne has no pension income, but would pay 21% on the first $44,000. If Bill shifts $37,500 (50% of his pension income) to Marianne, they would put them both in the 21% tax bracket.
Confusion surrounding pension income-splitting often comes down to what qualifies as pension income. That depends on your age, but generally the eligible income is similar to what qualifies for the pension-income tax credit.
If you are a spouse age 65 or over, you can split your company pension plan, RRIF income, annuity payments and pooled registered pension plan (PRPP). If you are younger than 65, you can still split your workplace pension plan. But you can only split your RRIF, annuity payment or PRPP if you are receiving that income due to the death of your spouse, DiPietro says. "The income that qualifies is much more flexible when you reach age 65."
Old Age Security and Canada Pension Plan payments are not eligible for income-splitting, regardless of age. CPP actually has its own separate income-splitting initiative, called pension- sharing. Unlike pension income-splitting, CPP pension-sharing is not completed through the tax return. Couples have to apply directly by filling out Form ISP1002 , and sending it directly to Service Canada.
When it comes time to collect a CPP benefit, a retiree could elect to share that pension or combine the credits that they each accumulated during the time they were together," DiPietro says. Then Service Canada will send the split amount directly to each spouse each month.
