For retired Canadians (and almost certainly for those who are no longer paying a mortgage) the annual income tax bill can represent the single largest expenditure in their budgets. The Canadian tax system provides a number of tax deductions and credits available only to those over the age of 65 (like the age credit) or only to those receiving the kinds of income usually received by retirees (like the pension income credit) to help minimize that tax burden. One of the most valuable of those strategies — pension income splitting — isn’t particularly familiar to many taxpayers who could benefit from it, especially those who do not receive professional tax planning or tax return preparation advice.
That’s a particularly unfortunate reality because pension income splitting has the potential to generate more tax savings among taxpayers over the age of 65 (and certainly those over the age of 71, for whom RRSP contributions are no longer possible) than just about any other tax planning strategy available to retirees. In addition, it’s one of the very few tax planning strategies which require no expenditure of funds on the part of the taxpayer and which can be implemented after the end of the tax year, at the time the return for that tax year is filed.
Those attributes can make pension income splitting sound like a “too good to be true” tax scam, but that’s not the case. Essentially, what pension income splitting offers is a government-sanctioned opportunity for married taxpayers over the age of 65 to make a notional reallocation of private pension income between them on their annual tax returns, and to benefit from a lower overall family tax bill as a result.
Pension income splitting, like all forms of income splitting, works because Canada has what is called a “progressive” tax system, in which the applicable tax rate goes up as income rises. For 2016, the federal tax rate applied to about the first $45,000 of taxable income is 15%, while the federal rate applied to the next $45,000 of such income is 20.5%. So, an individual who has $90,000 in taxable income will pay federal tax of about $16,000; if that $90,000 was divided equally between said individual and his or her spouse, the total federal family tax bill would be $13,500.
The general rule with respect to pension income splitting is that taxpayers who receive private pension income during the year are entitled to allocate up to half that income (without limit) with a spouse for tax purposes. In this context, private pension income means a pension received from a former employer and, where the income recipient is over the age of 65, payments from an annuity, a registered retirement savings plan (RRSP), or a registered retirement income fund (RRIF). Government source pensions, like the Canada Pension Plan or Old Age Security payments, do not qualify for pension income splitting, regardless of the age of the recipient.
The mechanics of pension income splitting are relatively simple. There is no need to transfer funds between spouses or to make any change in the actual payment or receipt of qualifying pension amounts, and no need to notify a pension administrator. Taxpayers who wish to split eligible pension income received by either of them must each file Form T1032, Joint Election to Split Pension Income for 2016, with their annual tax return. That form, which is not included in the annual tax return package, can be found on the Canada Revenue Agency (CRA) website at www.cra-arc.gc.ca/E/pbg/tf/t1032/README.html, or can be ordered by calling 1-800-959 8281.
On the T1032, the taxpayer receiving the private pension income and the spouse with whom that income is to be split must make a joint election to be filed with their respective tax returns for 2016. Since the splitting of pension income affects the income and therefore the tax liability of both spouses, the election must be made and the form filed by both spouses – an election filed by only one spouse or the other won’t suffice. In addition to filing the T1032, the spouse who is the actual recipient of the pension income to be split must deduct from income the pension income amount allocated to his or her spouse. That deduction is taken on Line 210 of his or her 2016 return. And, conversely, the spouse to whom the pension income amount is being allocated is required to add that amount to his or her income on the return, this time on Line 116. Essentially, to benefit from pension income splitting, all that’s needed is for each spouse to file a single form with the CRA and to make a single entry on his her 2016 tax return.
By the end of February or early March, taxpayers will have received (or downloaded) the information slips which summarize the income received from various sources during 2016. At that time, couples who might benefit from this strategy can review those information slips and calculate the extent to which they can make a dent in their overall tax bill for the year through a little judicious income splitting.
Those wishing to obtain more information on pension income splitting than is available in the 2016 General Income Tax and Benefit Guide should refer to the CRA website at www.cra-arc.gc.ca/pensionsplitting/, where more detailed information is available.
The information presented is only of a general nature, may omit many details and special rules, is current only as of its published date, and accordingly cannot be regarded as legal or tax advice. Please contact our office for more information on this subject and how it pertains to your specific tax or financial situation.