How to split pension income to save taxes in Canada

Retirement planning is crucial for securing a comfortable financial future. For Canadian couples, understanding how to split pension income effectively can significantly reduce your tax burden and maximize your retirement savings. This article provides a comprehensive guide on pension income splitting in Canada, covering eligibility criteria, eligible income types, the process, and key considerations.

How to split pension income to save taxes in Canada involves a legal process where a portion of eligible pension income is transferred to a lower-earning spouse or common-law partner to take advantage of lower tax brackets. This strategy can result in significant tax savings for couples.

Understanding Pension Income Splitting

Pension income splitting allows a pensioner to allocate up to 50% of their eligible pension income to their spouse or common-law partner, effectively transferring a portion of the tax burden to the lower-income earner. This strategy can significantly reduce a couple's overall tax bill. The transfer is notional; no funds are physically exchanged. It's simply an adjustment made on your tax returns.

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Who is Eligible for Pension Income Splitting?

To be eligible for pension income splitting, you and your partner must meet the following criteria:

• You and your partner must be residents of Canada.
• You must be receiving eligible pension income.
• You must generally be in a higher tax bracket than your partner.
• You and your partner cannot be living separate and apart due to a relationship breakdown for a period of 90 days or more within the tax year.

The age of the pension recipient matters for income splitting, while the age of the receiving spouse matters for the pension income tax credit.

What is Eligible Pension Income?

Eligible Pension Income for those 65 or older:

If the pension recipient is 65 or older at the end of the year, eligible income includes:

• Taxable part of life annuity payments from a superannuation or pension plan
• Payments from a Registered Retirement Income Fund (RRIF), Life Income Fund (LIF), or Restricted Life Income Fund (RLIF)
• RRSP annuity payments (not regular RRSP withdrawals)
• Deferred Profit Sharing Plan (DPSP) annuity payments
• Pooled Registered Pension Plan (PRPP) payments
• Regular annuities and Income-Averaging Annuity Contracts (IAAC)
• Qualifying amounts from a Retirement Compensation Arrangement (RCA)
• Certain foreign pension plans (including U.S. Social Security)

Eligible Pension Income for those under 65:

If the pension recipient is under 65, eligible income is more limited:

• Taxable part of life annuity payments from a superannuation or pension plan
• Payments from a RRIF, LIF, or RLIF due to the death of a partner
• Certain foreign pension plans

Income Not Eligible for Splitting

Several types of income are explicitly excluded from pension income splitting:

• Canada Pension Plan (CPP) and Quebec Pension Plan (QPP) payments
• Old Age Security (OAS) payments
• Guaranteed Income Supplement (GIS) payments
• U.S. Individual Retirement Account (IRA) income
• Death benefits
• Retiring allowances
• Most RRSP withdrawals

How to Split Your Pension Income

The splitting process involves completing and submitting Form T1032, Joint Election to Split Pension Income. This form must be attached to both spouses' tax returns and filed by the tax deadline. The form requires information on the total eligible pension income and the desired amount to split (up to 50%). Withholding tax related to the split income is also allocated proportionally.

Pension Income Splitting and Tax Software

Many tax software programs can help calculate the optimal amount of pension income to split based on your specific financial situation. They can also automatically populate the necessary forms. However, it's always recommended to consult a tax advisor for personalized advice.

Other Considerations

Spousal RRSPs

Spousal RRSPs can complement the pension income splitting strategy by allowing for income splitting before age 65, subject to attribution rules.

OAS Clawback

Pension income splitting can help mitigate the OAS clawback by reducing individual incomes and keeping them below the threshold.

Pension Income Tax Credit

The pension income tax credit allows for a 15% federal credit (plus provincial credits) on the first $2,000 of eligible pension income. Splitting income can potentially double this credit for couples where both spouses qualify.

Conclusion

Splitting pension income is a valuable tool for Canadian retirees seeking to minimize their tax burden. By understanding the eligibility rules, eligible income types, and the splitting process, couples can maximize their after-tax retirement income. However, given the complexities of tax law, consulting with a qualified tax advisor is crucial for personalized advice and optimal tax planning. A careful review of your individual circumstances will ensure you're maximizing the benefits of this strategy. How will you incorporate pension income splitting into your retirement plan?

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