Pensions: To split or not to split

The pros and cons of splitting pension income in order to share earnings between the spouses.

For five years now Canada Revenue Agency (CRA) has permitted couples to split pension income in order to share earnings between the spouses, an attractive tax policy given Canada’s progressive tax rate scheme especially when one spouse has a hefty pension and the other has little or none.

In effect CRA is allowing a reduction, and in some cases even the elimination, of a couple’s overall tax liability since two smaller incomes are taxed at a lower rate rather than a larger income taxed at a significantly higher rate.

Ironically, there are favourable tax breaks that may be negatively impacted by a pension split so some arithmetic is necessary to ensure that the split isn’t actually costing more in tax than if it were not split.

Often a pension split prevents the old age security “claw-back” that occurs when a person has income greater than the threshold amount by transferring income from the higher earner to lower earner.  However, in some cases the amount of income needed to be transferred to lower the one spouse’s income to eliminate the claw-back may, in actual fact, increase the other spouse’s income to the point where the claw-back now applies to them.  The appropriate split to avoid this must be calculated.

The other balance to establish concerns the federal age tax credit.  The transfer of income between spouses may directly affect the size of the tax credit for both spouses so it’s important that the gain in tax credit for one spouse is not offset by a greater loss in credit for the other spouse.

Then again, and this is the real stickler with this tax credit, even though the age tax credit may be lost for one spouse due to a pension split, the overall tax savings may outweigh the loss of that credit.  Mathematically this is possible and has to be calculated.

In general though, pension splitting is a straight forward procedure when a person is 65 or older and receiving eligible pension income that includes funds from annuity payments from a registered pension plan, retirement savings plan, retirement income fund and deferred profit sharing plan.  Up to 50 per cent of the pension income can be split with the spouse.  If younger than 65, only registered pension plan income or pension income received because of the death of the spouse can be split.  The recipient spouse of income from a pension split can be any age, a point often missed that could cost thousands in taxes.

A pension split can save more than taxes, mitigate the old age security claw-back and maximize the age tax credit, it may also allow for double dipping when it comes to the pension tax credit.  That is, if one spouse has no eligible pension income and because of the pension split now has pension income, that spouse becomes eligible for up to a $2,000 pension credit, in effect doubling the pension credit for the couple.  Both spouses have to be 65 or older to qualify.

Word of caution.  Not all software programs will do the calculations for the various permutations to create the ideal pension income split.  Read the software instructions and to be safe, do the calculations by hand, or have a professional do them.  Finally, both spouses have to sign the T1032 that is required to be completed for both returns.

Ron Clarke has his MBA and is a business owner in Trail, providing accounting and tax services. Email him or see all previous columns at ron.clarke@JBSbiz.ca

 

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