Thursday, April 9, 2015

Splitting the Fruits of Your Labour


The month of April is a reminder that it’s “Tax Time.” However, any time throughout the year is a good time to examine whether you are taking advantage of every available opportunity to reduce taxes.  One of the best tax opportunities given to Canadians was the ability to split pension income between spouses and common-law partners.  This privilege was granted in 2007.  Since then, you may have read the information or watched the video on pension income splitting at the Canada Revenue Agency’s website.  Repetition about this subject is beneficial since there’s always an opportunity to learn something new, or discover whether you have overlooked or even misunderstood the process.

Understanding which types of pension income are eligible for splitting and when the pension income can be split seems to be the biggest challenge.  You don’t necessarily have to be 65 years old to split specific income as shown below in the chart. 


Recipient At Least

65 Years Old

Recipient Under

65 Years of Age

·        Term or life annuity payments from a registered pension plan


·        Term or life annuity payments from an RRSP or DPSP


·        Payments from a RRIF, LIF or LRIF


·        The income element of an unregistered annuity payment

·         Life annuity payments from a registered pension plan.


·        The full amount of annuity payments from an RRSP, RRIF, DPSP or other registered plan, but only if those payments are a result of the death of a taxpayer’s previous spouse or common-law partner (and even then, pension splitting can only take place if the taxpayer has remarried.)


·        The income element of unregistered annuity payments, but only if those payments are a result of the death of the taxpayer’s previous spouse or common-law partner (and even then, pension splitting can only take place if the taxpayer has remarried.)
Prominent Types of Pension Plans
Defined Contribution Plan
Knowing specifically what type of pension plan you have through your place of employment will help you understand your options at retirement.  Today, the most preferred choice of pension plan, from an employer’s perspective, is a Defined Contribution Plan (DCP).  The contributions are made to the pension plan by both the employer and employee based on percentage of salary. The alternate name for this pension plan is “money purchase plan.”  Every dollar is deposited into your pool. 
With a Defined Contribution Plan, there are two options at retirement:
1.    A retiree can convert the “pool of money” into an annuity which provides a retirement income for life.  If this option is chosen, then eligible pension income is created which, regardless of your age, can be split with a spouse.
2.    A retiree can choose to manage withdrawals from a Defined Contribution Plan (DCP) in the same way withdrawals are made from Registered Retirement Savings Plans (RRSPs) and Registered Retirement Income Funds (RRIFs).  If this option is chosen, then a person must be at least 65 before eligible income can be split with a spouse. 
Defined Benefit Plan
With the Defined Benefit Plan (DBP), the contributions are likewise made by the employee and employer. The one difference between a DC and DB pension plan is the employer is responsible for any shortfalls in the DB plan. Notably, the specific retirement benefit then has been pre-set, based on a formula calculated as a percentage of salary and the number of years of service.  When a person is eligible for retirement, regardless of age, this benefit can be split with a spouse.        
Clarifying The Confusion
Even though both Defined Contribution Plans and Defined Benefit Plans are considered registered pension plans, it’s the method of payments that dictates whether the amount can be split with a spouse.  To avoid any confusion, a text-boxed message on CRA’s website clarifies the process to ensure everyone is aware that the variable benefits from a DCP are different from DBP until the pensioner is age 65.
Variable pension benefits paid from a money purchase provision of a registered pension plan or payments out of a pooled registered pension plan are not considered life annuity payments and do not qualify unless the pensioner is age 65 or older at the end of the year or the variable benefits or payments are received as a result of the death of a spouse or common-law partner.
How You Make This Work To Your Advantage
Eligibility for splitting income factors in age and the type of pension income.  Understanding your specific type of pension plan will help determine the best approach to layering retirement income. Then specific strategies will align your retirement income to match your needs and manage taxes.
Depending on your situation, these are some possible strategies:
·         You may withdraw less from your DC plan prior to age 65, knowing that after age 65 you can withdraw a greater amount since eligible pension income can be split with your spouse.
·         You may choose to accelerate withdrawals at age 65, knowing you have the ability to split eligible income with a spouse and pay less personal income tax as a couple than if you were widowed. 
·         You may choose to withdraw money from your RRSP/RRIF prior to age 65 while you shift eligible DB pension income to your spouse.
You must not assume you have to split 50% of your pension. The wording is, “up to 50% of eligible pension income.” This isn’t an “all or nothing” approach.  You elect to split the ideal amount which may help lower a spouse’s taxable income while not eroding tax credits or benefits. It truly is a balancing act. Working with a Certified Financial Planner will help you determine the ideal strategy for you.

When Does Pension Splitting Take Place
The “Pension Splitting” election is made by you, as a couple, when you file your tax returns. Form 1032 specifies the dollar amount (a percentage of income) allocated between both each tax year.  This entire process takes place only on “paper;” money is not physically transferred between spouses. Spouses are known to help pay for the tax bill especially when the lower-income spouse, who normally would pay less tax, now is obligated to pay more as a result of pension splitting.  The overall benefit ensures a couple pays less tax as a household whether the tax saving is significant or not.
Another “Impressive” Reason for Splitting Income
The added advantage for splitting pension income is that a spouse may also utilize the pension income credit.  A federal tax credit is awarded on the first $2,000 on pension income for any individual having qualifying pension income.  A similar tax credit is available in Saskatchewan for the first $1,000 of pension income.   A couple certainly would want to take advantage of offsetting taxable pension income with these credits.  

Putting Pension Splitting In Reverse
The ability to split eligible pension income is also known to work in reverse.  The pension income from a lower-income tax payer can be transferred to the higher-income tax payer in order to prevent a spouse’s Old Age Security from “claw-back” or which is properly known as the Old Age Security Recovery Tax.  The same can be true for using “reverse pension splitting” to preserve the age credit amount where a spouse may be disqualified because their income exceeds the threshold.  This reverse strategy is used to reduce the overall household tax bill by ensuring the tax credits are fully utilized while maintaining income within the specific tax brackets.   Since everyone’s tax circumstances are unique, having the appropriate tax preparation software or a tax professional to help determine the ideal split would be most advantageous.
Pension Income Not Eligible
From the above list of eligible pension income, these are not included: Canada Pension Plan, Old Age Security, and Guaranteed Income Supplements. However, Canada Pension Plan does have its own mechanism for sharing benefits with a spouse.  Learn more about sharing Canada Pension Plan benefits here.
Your Money
I would venture to guess most people have heard of pension splitting but there are still many who question the process.  These questions have been brought up during my client meetings.  Always discuss your specific situation with a qualified individual who can help determine the best tax outcome for you.  After all, doesn’t everyone want to have more money to spend?  



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