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.
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Recipient At Least
65 Years Old
|
Recipient Under
65 Years of Age
|
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·
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.
Note
|
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.
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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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