The latest instalment of my MoneySense Retired Money column is now available: click on the highlighted text to access the full version of the column: Pay Less Tax with Pension Income Splitting.
As I note, It’s hard to believe but the great boon of pension income splitting has now been available to Canadian retirees for a full decade. Coupled with the 2009 introduction of TFSAs, these two tools have certainly been a welcome addition to the arsenal of retirees and semi-retirees.
Pension splitting can generate many thousands of dollars in additional after-tax income for retired couples, particularly if – as is often the case – one of them enjoys a generous defined benefit (DB) pension and the other does not. Pension splitting is based on the fact that Canada’s graduated income tax system imposes far higher rates of tax on big earners than on modest or non-existent earners. Pension splitting can result in a highly taxed income and a low-taxed one being merged (conceptually speaking) into what amounts to a modest mid-level amount of tax for the couple as a whole, putting thousands of extra dollars into the family’s collective pocket each year.
The tax benefits vary with the marginal tax rates of both spouses. With pension splitting, if one spouse has no pension and the other has a $60,000 pension the couple as a whole ends up being treated exactly like a couple with two $30,000 pensions. The bonus is that both spouses can claim the $2,000 pension income s and the higher-income spouse may no longer be subject to clawbacks of Old Age Security.
Pension Splitting is a paper transfer at tax time
This is all perfectly legal and accomplished merely by electing to declare your income this way each year when you prepare your tax returns. It’s a “paper transfer,” so you don’t even have to write a cheque or hand over cash to your spouse.
Many couples may need to wait till age 65 to benefit from pension splitting, at which point eligible pension income includes lifetime annuity payments under a Registered Pension Plan, RRSP or Deferred Profit Sharing Plan (DPSP) and payments from Registered Retirement Income Funds (RRIFs) and Life Income Funds.
For those under 65, eligible pension income includes lifetime annuity payments from an RPP (i.e. payments from your DB plan or DC plan if you purchased a life annuity) and some payments received when a partner dies. Remember, though, the lower earner cannot receive more than 50% of the pension for tax purposes: unlike spousal RRSPs, which are not constrained by any maximum. See below for more on that topic.
Spousal RRSPs often overlooked
Meanwhile, on a related topic, on Wednesday, the Financial Post’s RRSP Special Report included my piece, headlined Spousal RRSPs are on often overlooked retirement savings tool. Click on the highlighted text for full column.