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Word of caution; optimizing a pension split is not simple

Tax Tips & Pits with Trail business owner Ron Clarke of JBS Business Services
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Up to 50 per cent of the eligible pension can be split with the spouse of any age but if under 65, there is a restriction on types of eligible pension.

by Ron Clarke

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It was the 2007 tax year when the government allowed couples to split pension income.

This was not only an attractive tax policy, but a fair policy given Canada’s progressive tax rate system.

Pension splitting allows one spouse with a hefty pension to share the income with the other spouse who has lower or perhaps no income, lowering the overall tax burden to the household.

However, despite this favourable tax break, there are credits and payments that can be negatively impacted by a pension split so some math is necessary to ensure that the split doesn’t actually cost more than if it were not split.

A pension split can prevent the old age security “claw-back” that occurs when a person has income greater than the threshold amount.

However, in some cases the amount of income needed to be transferred to lower one spouse’s income to eliminate the claw-back can, 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.

A similar issue arises with the federal age tax credit. The transfer of income between spouses can 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 the credit for the other spouse.

Then again, in its totality, sometimes the complete loss of a credit is outweighed by the aggregate reduction in taxes created by the split. Mathematically this is possible.

A pension split may also lead to double dipping when it comes to the pension credit.

That is, if the receiving spouse has no eligible pension income, once having pension income due to the pension split, that spouse can qualify for up to $2,000 of the pension credit, in effect doubling the pension credit for the couple.

For this double dip, each spouse must be 65 or older.

To be eligible for pension splitting, the transferring spouse must be receiving eligible pension income such as superannuation or a private pension plan or be over 65 to then include annuities and RIF payments.

Up to 50 per cent of the eligible pension can be split with the spouse of any age but if under 65, there is a restriction on types of eligible pension.

Only registered pension plan income or pension income received because of the death of the spouse can be split.

With regards to the government’s various pension incomes, these cannot be split.

However, spouses can elect to pool this pension income and receive a shared amount of this total income, in effect splitting income and reducing overall taxes.

This election is made directly to the Canada Pension Plan and not through CRA.

The process of optimizing a pension split is not simple, and if doing it by hand use a calculator, pencil and paper, and have an eraser handy!

Or consider software, and really, software is the only efficient way to optimize a pension split.

On this point, a word of caution.

After your returns are prepared, be sure your final step in your tax prep is to optimize the pension split to ensure any late changes you may have made to either of your tax returns is taken into account by the software.

The smallest change can totally change the pension split.

Ron Clarke is owner of JBS Business Services in Trail, providing accounting and tax services.