In June 2007, the Parliament of Canada signed into law one of the most significant changes to Canada's tax system in recent memory.
The new provision allows "pension income splitting" for spouses and common-law partners. Under these rules, a spouse who has "eligible pension income," which is income that qualifies for the federal pension income credit, can allocate up to 50 per cent of this pension income to the other spouse for tax purposes. This can be a very effective way to lower a household's overall tax bill.
With tax season looming, many Canadians - including those currently retired and those approaching retirement - will discover that this new provision is not as simple as it looks. There are a number of specific rules and conditions that govern every tax provision, and pension income splitting is no exception.
Following are six facts about pension income splitting to help Canadians make the most of this opportunity:
Pension income that qualifies for splitting may depend on your age. A monthly benefit from a registered pension plan is eligible for income splitting at any age. However, Registered Retirement Income Fund (RRIF) income is eligible for income splitting only if you have attained age 65.
Using the pension-income-splitting option could allow both spouses to take advantage of the pension income credit. For example, if the recipient of RRIF income is at least 65, that income qualifies for the pension income credit, and up to 50 per cent of the income is eligible for allocation to the spouse. If the spouse who receives the allocation of the RRIF income is at least 65, that spouse is also able to claim the pension income credit. (If the spouse receiving the allocation is under 65, pension income splitting can occur even though the pension income credit is not available).
Pension income splitting could provide for overall tax savings and also increased Old Age Security (OAS) benefits. For example, if a senior is receiving eligible pension income, and his or her total net income for 2007 is between $63,511 and $103,000, the OAS benefits are subject to clawback. However, the net income can be reduced through the allocation of up to 50 per cent of the pension income to the spouse. By reducing this net income, more of the OAS benefit will be retained, plus there could be an overall family tax savings through the allocation to the lower-income spouse.
Pension income splitting could have an impact on several other tax calculations and credits including medical-expense credits, spousal credit, age credit, and quarterly tax installments. For example, the amount eligible for the medical credit in 2007 is equal to the total medical expenses that exceed the lesser of 3 per cent of net income and $1,926. In order to maximize the credit, the lower-income spouse normally makes this claim. However, if the spouse's net income is increased through an allocation of pension income, this would reduce the amount eligible for the medical-expense credit.
Pension income splitting does not require the physical transfer of funds. The income splitting occurs when tax returns are filed. The spouse who receives the eligible pension income makes an allocation of up to 50 per cent of this income to the other spouse. A new tax form called T1032, "Joint Election to Split Pension Income" will be used to make the annual allocation. The "allocating" spouse will reduce their taxable income on the tax return by the amount of the allocation, and the "receiving" spouse will add this amount to taxable income on their tax return.
Pension income splitting is not new. CPP/QPP income splitting (or income sharing) has been allowed for several years. However, under CPP or QPP, each of the spouses receives a separate payment. There is no "allocation" made through the tax return.
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David Ablett is a senior tax and retirement-planning specialist with The Investors Group.
