65 is the official age for retirement as per the Canada Revenue Agency (CRA). Hence, you become eligible for several cash benefits and tax credits once you turn 65. You can get government-funded cash benefits like Old Age Security (OAS) and Guaranteed Income Supplement (GIS), which depend on your income. You can also get self and employer-funded Canada Pension Plan, Registered Retirement Income Fund (RRIF) withdrawals, and tax credits, like age amount and pension income credit. Navigating all these benefits efficiently and maximizing your retirement income requires tax planning. Pension income splitting is one of the tax strategies couples commonly use.
Understanding The Working of Pension Income Splitting
Pension income splitting allows an individual receiving a pension to split up to 50% of that income with their spouse. But why would one do that?
A spouse who is in the higher income bracket can reduce their taxable income by showing some of the pension income on the tax returns of the spouse in the lower income bracket. There is no physical exchange of money. The couple jointly files Form T1032, Joint Election to Split Pension Income, specifying the amount of pension income they wish to split and accordingly calculate taxable income. This form has to be filed every year along with the income tax return before the tax filing deadline.
If any tax is withheld from your pension income, the same will be withheld for your spouse, too. This withheld tax will be used to reduce the income tax liability or refunded. Let’s understand this with an example.
Jacob has retirement income of $100,000, of which $70,000 is eligible pension income. His spouse, Nancy, has an annual income of $20,000. He can split his pension income of $33,000 with Nancy and increase her taxable income to $53,000, still within the 15% tax bracket, and reduce his taxable income to $70,000.
While their total family income remains unchanged, their individual personal income tax liability reduces. Whether this is a good strategy or not depends on a few factors.
Things to Consider For Pension Income Splitting
The CRA’s tax credits and cash benefits are progressive. They often have a minimum income threshold, and the benefit starts reducing if your income exceeds that amount. So, while splitting pension income, you should take into consideration several factors:
Age Amount Credit
Eligible Canadians over age 65 can claim this tax credit if their income is below a certain annual threshold. If your income is below a lower threshold set for the year, you can deduct the maximum age amount from your taxable income. Beyond this, the age amount you can claim starts to reduce.
Pension Income Credit
Both spouses above 65 can claim a federal tax credit on a portion of their eligible pension income, up to a specified annual amount. There is a long list of what pension income is eligible for this credit. In some instances, such as the death of a spouse, the surviving spouse under 65 may also claim a pension income credit.
OAS Clawback
Eligible seniors receive an Old Age Security (OAS) pension. However, if your individual taxable income for the year is between the minimum and maximum income thresholds, you must repay a portion of your benefit. This is often called the “OAS clawback.” You can receive the maximum OAS pension if your taxable income is below the minimum repayment threshold for that year. After that, the CRA claws back a percentage of the surplus income from your OAS amount.
By splitting pension income, a couple can lower the higher-earning spouse’s taxable income. This strategy can help them maximize benefits like the age amount credit and receive the full OAS pension without a clawback.
A professional accountant can help you crunch the numbers and determine the right amount of pension income you should split to maximize all the benefits you qualify for.
Do You Qualify For Pension Income Splitting
Like all CRA benefits, pension income splitting also has a long list of eligibility criteria, depending on the type of pension income, your tax status, and more.
Pension income: Note that government-distributed pensions, such as OAS, CPP, GIS, or a United States Individual Retirement Account, or foreign pension income that is tax-free in Canada, do not qualify for pension income splitting. Other arrangements, like salary deferrals, RRSP withdrawals, death benefits, and retiring allowances, also do not qualify.
So what qualifies for splitting? Eligible pension income typically includes:
- Payments from a Registered Pension Plan (RPP)
- Registered Retirement Savings Plan (RRSP) annuity payments (Note that RRSP withdrawals are different from annuity payments).
- RRIF Payments
- Certain annuity payments
If the spouse with whom you are splitting pension income is under 65, the list of eligible pension income reduces to RPP payments and certain annuities.
Each individual has a different scenario, and plugging the eligibility criteria into your scenario requires a thorough understanding of the rules and the changes that are announced from time to time. If you split ineligible pension income, it could trigger CRA scrutiny. A skilled accountant is well-versed in the rules and can help you stay accurate and compliant with your tax filing and minimize the chances of CRA scrutiny.
Contact MW&CO in Woodstock to Help You Maximize Pension income and Minimize Taxes
Talk to a professional accountant to discuss your retirement income and plan your taxes and benefits. At MW&CO, our accountants and tax advisors can provide services such as tax planning and filing. To learn more about how MW&CO can provide you with the best accounting and tax planning expertise, contact us online or by telephone at 519-539-6109 or toll-free at 1-877-539-6109.