Tag Archives: spousal RRSPs

Retirement shouldn’t be a Taxing transition for couples

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By Matthew Ardrey, Tridelta Financial

Special to the Financial Independence Hub

When people think of retirement, they make think of relaxing at the cottage, travelling the world, or maybe with the recent blasts of winter we have been receiving, spending some time in warmer climates. What most people don’t think about is how their taxes are going to change. Yes, with April just around the corner, it’s time to think about taxes and how they will impact you in retirement could be the difference between lying on a beach in February and shovelling your driveway for the fifth time this week.

Pension Splitting

If like many Canadians, you are a couple where both spouses work, the opportunities to split income are few and far between. In retirement that changes for the better. A number of years ago the government introduced legislation that allows pension income to be split between spouses. If you are already the lucky recipient of income from a defined benefit (DB) pension plan, you can further benefit by splitting up to 50% of this income with your spouse. The obvious benefit to this is the lower income spouse would pay less tax on the pension income than the higher income spouse.  Also, he/she would now receive the pension credit, which is a non-refundable federal tax credit that maxes out at $2,000. So depending on the disparity of the tax rates between spouses and size of the pension, this could be a material benefit to their tax returns saving thousands of dollars a year in taxes.

Ok, that is great for those Canadians who have a pension, but what about the rest of us?

What if you don’t have a splittable pension?

Once a taxpayer is over the age of 65, they can split life annuity, RRIF and LIF income in the same manner as DB pension income. This can lead to some interesting tax planning for someone who is doing a RRSP meltdown strategy. If one spouse has a much larger RRSP/RRIF than the other, they can double the meltdown amount by taking it from a RRIF instead of a RRSP after the age of 65. In doing this, the RRSP (or RRIF in this case) meltdown strategy could be extended to age 70, with CPP and OAS deferrals.

Other benefits to income splitting include being able to claim the age amount tax credit and possibly reducing or eliminating OAS clawback.

The mechanism for doing this in your taxes is relatively straightforward and does not have to be implemented until you file your taxes the following April. There is a form T1032 in your tax return where you make the pension election. Most tax software these days will do the calculation for you. Once all of your other information is entered for you and your spouse, the software will optimize the pension splitting between spouses. Even if you both have a pension, it can do this for you.

The topic of income splitting continues with your government pensions. Though OAS is not eligible to be shared, the CPP is. You and your spouse can apply to share your CPPs. You both have to be contributors at some point in your lives and both be receiving the pension. The amount eligible to share is based on your joint contributory period, which is just a fancy way of saying the time you were married or cohabitating. The benefit increases with the difference between CPP payment amounts.

While we are on the topic of CPP, I thought it was important to mention the child-rearing drop out provision. Unlike the general drop out provision, which is calculated automatically, the child rearing must be applied for.

How does the CPP drop-out provision work?

Let’s take you back to grade school where we learned about fractions. The CPP you receive is a fraction of the maximum payable, ignoring any early penalties or deferring benefits. The total number of years is 47 (age 18-65). The general drop out provision eliminates the lowest eight, making the denominator 39. Any year you make the maximum contribution you get a 1 in the numerator and if not, then a number between 0 to less than 1.

The child rearing drop out provision allows a spouse who may have stopped or reduced their work due to child care, to eliminate up to seven years per child (no double counting years if you have children close in age). The benefit is any year that has less than a 1 in the numerator that is eliminated, will increase the overall CPP payable to you.

Another tax surprise for many retirees is tax installments. If you were self-employed, you will be familiar with these, but many salaried employees are not. Tax installments are requested by CRA once your taxes payable less your taxes deducted at source exceed $3,000. While working, your employer took taxes at source. In addition, you probably had RRSP deductions and other things that reduced your taxes or generated you a refund. Now with RRIF payments, CPP, OAS and other incomes, you may end up owing taxes. Continue Reading…

FP: How retired seniors can use their spouse as a tax asset

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My latest Financial Post column has just been published in the print edition of the Wednesday paper (Feb. 27, page FP8), under the headline Top tax asset in Retirement? Think Spouse. Click on the highlighted text to access the full story  via the National Post e-paper. Or for the website edition, click on this clever headline: Your biggest tax asset in Retirement may be sleeping right beside you.

The column looks at how senior couples approaching Retirement or semi-retirement face a slightly different tax situation than when both were working in full-time jobs. There’s limited scope for income splitting when you’re working but Pension Income Splitting — introduced more than ten years ago — is a real boon for senior couples that enjoy one fat employer-provided pension and the other does not.

For tax purposes, up to half of the pension can be “transferred” to the lower-income spouse’s hands, thereby reducing some of the highly-taxed income for the pension recipient, and putting more of the pension into the low-taxed hands of the spouse receiving some of the transfer. Note this doesn’t actually mean they receive the pension: it all happens on the tax returns, and is easily handled by tax software when you choose to file your taxes jointly as a couple. Note that unlike in the United States, there is no formal joint tax return for couples in Canada: each spouse must file on their own but the tax software makes it relatively smooth by creating so-called “Coupled Returns,” which helps optimize who claims deductions like charitable or political contributions and the like.

Because the column has to fit in the paper and included several sources (some of whom blog here at the Hub), I’ve taken the liberty of adding some of the points made that did not appear in the column or had to be truncated.

Income splitting options limited under age 65

Under age 65, the options for income splitting are very limited, says Aaron Hector, vice president of Calgary-based Doherty Bryant Financial Strategies.  “Generally here you are only looking at payments out of defined benefit plans (of which  up to 50% can be split) or spousal loans from non-registered investments.”

Doherty Bryant’s Aaron Hector

More from Aaron Hector:  “If each spouse has their own registered plan (RRSP/RRIF/LIRA/LIF) then the withdrawal from their own personal plan can be taxed fully to them. So if one spouse is working, they may not need or want to draw any additional income from their registered plans, but the spouse who is not working can choose to draw down their registered plan. It is important to note that regular RRSP withdrawals will never qualify for income splitting, even after 65. The withdrawals need to come from a RRIF to be eligible for income splitting. Sometimes people are hesitant to convert their RRSPs into RRIFs because they don’t yet want to commit to the subsequent forced annual taxable RRIF withdrawals. What is less commonly known is that someone can convert only a portion of their RRSP into a RRIF, leaving the remaining RRSP balance untouched until it is forced into being converted into a RRIF by the end of the year in which they turn 71. Furthermore, if someone converts to a RRIF early (ie. before 71) then they will always have the option to convert their RRIF back into a RRSP anytime before 71. Doing so would allow them to ‘turn off the taps’ that is the RRIF income stream. Once you turn 65 (but not before) withdrawals from RRIFs and LIFs become eligible for income splitting. Only the spouse who’s RRIF/LIF is being drawn upon needs to be 65; the recipient of the income splitting can be younger than 65. However, in this case the recipient spouse will not get the “pension income tax credit” until they are also 65.

It’s also important to note that when it comes to these income splitting provisions, age 65 at any point of the year is sufficient. If you turn 65 on December 31, then the same 50% splitting provisions apply to you as if your birthday was on January 1. (ie. the splittable portion does not get pro-rated in the year you turn 65 depending on your specific birth date). Because of the age 65 significance, and also as a hedge against future governments changing the tax rules (ie. taking away pension income splitting rules, which have not always been allowable) I try to have my client couples have an even amount of money in their registered plans. Spouse 1 should add up their RRSP, LIRA, Spousal RRSP, etc.. and the total should be close to the same total of spouse 2. If there is a discrepancy, then Spousal RRSP contributions should be utilized to even things out. This allows flexibility in income planning and withdrawals in the years prior to age 65. I caution on Spousal RRSP contributions the closer someone is to needing the money because of the 3 year-rule. The 3-year rule is such that if a withdrawal is made in the year of a contribution, or either of the next two calendar years, then the income from that withdrawal will be attributed (ie. taxed) back to the contributing spouse instead of the Spousal RRSP account holder.”

Taxation of Non-registered income works differently

Income from non-registered accounts works a bit differently, Aaron notes: Continue Reading…

Stop cheating yourself out of tax savings: Tips to get the biggest refund

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By Clayton Brown

(Sponsor Content)

The CRA might not exactly be falling over themselves to help you get a nice tax refund. A recent audit showed the agency blocked more than half the calls it was getting (that’s 29 million calls out of 53.5 million) because … well, it just could not handle all of the call volume.

And even when Canadians did get through, agents gave the wrong information about 30 per cent of the time. So, Canadians might need a little help in figuring out how to file their taxes the right way; ideally, so they get the maximum refund they deserve.

Here are some things you can do around tax time to make sure you get the money that should be coming to you:

Take your deductions and claim your credits

The CRA likes its revenue but successive governments have created various options to give the taxpayer some breathing room. Deductions are one of the few variables in your favour, lowering your taxable income, so make the most of them.

Probably one of the best known ones comes from RRSP contributions.

You can contribute up to 18 per cent of your previous tax year’s earned income, plus unused room carried forward from previous years. This helps you pay less tax now, and assuming your income is lower in retirement, also helps you pay less tax later on. By now, you should have all your RRSP receipt slips from your financial institution. (Make sure you keep those receipts, in case auditors come calling).

Another tactic: claiming deductions for child care costs. The government wants to encourage parents to buff up their skills and improve their job prospects. For instance, you can deduct up to $8,000 per child who is under 7 years old. For children aged 7 to 16, you can deduct up to $5,000 for those eligible child care expenses.

Canadians can also claim the interest on certain student loans as a credit. This credit is not like a deduction (where a $1 deduction translates into $1 less taxable income, up to a limit). However, it can still significantly lower a tax bill for those struggling to finally pay off student debt after they’ve finished school.

There are many more deductions and credits available, so don’t leave money on the table!

Love those Spousal RRSPs

Marriage is a beautiful thing. Being with the person you love, sharing memories … and don’t forget about those tax advantages! (Technically, they also apply to common-law spouses, so you don’t have to get hitched to reap the rewards).

These tips generally apply where one spouse earns quite a bit more than the other. In that case, it can make sense for the higher-earning partner to contribute to a Spousal RRSP.

So, let’s say Ned makes $80,000 in salary at his engineering job. Meanwhile, Ned’s wife, Claire, earns just over $50,000 as a manager in an electronics store.

They are both contributing to their own individual RRSPs (Ned saved $6,000 in his. Claire saved $4,000). But Ned also puts $5,000 into a Spousal RRSP. Since Claire’s income is lower, she is the holder of the Spousal RRSP and she will be the one withdrawing income from it. The ideal result, if they’re doing it right: when she makes a withdrawal, it will be taxed at a lower rate than if Ned withdrew it from his own RRSP. Continue Reading…

Lending to Spouse at Prescribed 1% rate ‘Best Before’ April 1

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“Never spend your money before you have it.”
—Thomas Jefferson

I can’t emphasize enough that time is truly of the essence if you benefit from implementing this simple family lending practice. Interest rates are expected to inch up again and will alter the value of this tactic. Hence, I revisit the benefits of one of the few remaining family income splitting strategies.

It is commonly known as the “prescribed rate” loan. The procedure needs these components:

  • One spouse is in a lower tax bracket than the other, or earns little income.
  • The higher tax bracket spouse has cash to lend to the other spouse.

“The benefit of the prescribed loan strategy is a bigger family nest egg.”

Examine your family benefits from this income splitting opportunity. All loan arrangements and documentation must be in place by March 31, 2018 to derive maximum benefit. The key is to charge interest at least at the prescribed rate on cash loaned to a spouse/partner. That prescribed rate is now set at 1% for loan arrangements made by March 31, 2018.

The lower income spouse aims to accumulate a larger nest egg while the family pays less tax. The good news is that loans don’t have to be repaid for a long time, say 10 to 20 years or more.

My sample case highlights the income splitting strategy (figures annualized):

  • The higher tax bracket spouse lends $200,000 to the other at the 1% prescribed rate.
  • The recipient spouse invests the cash, say at 4% ($8,000) and reports the investment income.
  • The recipient must pay 1% annual interest ($2,000) to the lender spouse.
  • The lender spouse is taxed on the 1% interest, while the recipient deducts it.
  • The recipient is taxed on the net income generated ($8,000-$2,000).
  • This results in annual income of $6,000 shifted to the lower income spouse.
  • A promissory note is evidence for the loan.
  • A separate investment account is preferred for the recipient.
  • These loans are best made for investment reasons, such as buying dividend stocks.
  • A new 1% loan can also deal with an existing higher rate prescribed loan.
  • Multiple prescribed loans can be made at 1% while the rate does not change.
  • Business owners can investigate the viability of prescribed loans to shareholders.

Prescribed Rate Loan – Sampler

Here is a simplified method to think of such loans:

Cash Borrowed at 1% rate:  $200,000
Assumed Investment Income (4%): $8,000
Less: Prescribed Loan Interest (1%): $2,000
Taxable Income for Borrower Spouse: $6,000
Taxable Interest for Lender Spouse: $2,000

The benefit of the prescribed loan strategy is a bigger family nest egg. Your mission is to shift investment income into the hands of the lowest taxed spouse.

Need for speed

Today’s prescribed rate, which is set quarterly, is as low as it can be. However, it is most likely to rise at the next setting later this month. The prevailing expectation is a jump to 2% from the current 1% rate on April 01, 2018. Such an increase reduces the net value of the loan arrangement. Further, we may not enjoy a 1% rate for a long time, perhaps never again. Continue Reading…

Blend income splitting with retirement strategies

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My investing premise is straightforward: Splitting family income is very beneficial. Take full advantage of all provisions that apply.

Think of income splitting in the same breath as your retirement planning. In my view, the two camps ought to fit like a glove to deliver the best value. Families are keenly interested in paying the least income tax. There are a few low-cost activities left on the platter.

It’s never too early to get familiar with the menu. Let’s blend income splitting with your retirement strategies.

Ideally, a family pays less income tax where two spouses achieve similar income levels. Equalizing incomes allows each spouse use of the graduated tax scales from low to high.

Another beneficial goal is to equalize asset levels as much as possible. Retirees who reduce the “clawback” retain more of the OAS pension and, perhaps, the age credit.

A dozen tips for splitting income near retirement

Utilize these income splitting tips before and after retirement: Continue Reading…

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