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Narayan wants to know the best ways to save income tax, given the disparity between his income and his wife’s.
Q. Is it always advantageous to use pension income splitting? I have a very high pension income, but my wife does not have much.
–Narayan
A. Income splitting is a strategy to move income from a high-income taxpayer to a lower income family member, with an aim to lower the household’s overall tax bill. There are many ways to do this, but perhaps none is easier than pension income splitting in retirement.
Pension income splitting allows eligible pension income to be reallocated from one spouse to another. Practically speaking, it results in a tax deduction on line 21000 of a T1 tax return—a split-pension deduction—or the higher-income spouse. The recipient spouse claims an income inclusion on line 11600 for the split-pension amount. The result is that the income is effectively moved from one spouse to the other.
Married or common-law taxpayers jointly elect to split their pension income when they file their tax returns, so this is a retroactive tax strategy. This allows pension income splitting to be fine-tuned after the initial preparation of both spouses’ tax returns.
Eligible pension income has limits both before and after age 65. Before a pension income recipient reaches age 65, the most common sources of eligible pension income to split with their spouse include defined benefit (DB) pension income and taxable foreign pension income, like U.S. Social Security. (For the full list, see here.)
After age 65, more income sources become eligible, including Registered Retirement Income Fund (RRIF) withdrawals, defined contribution (DC) pension withdrawals and annuity income. Note that Registered Retirement Savings Plan (RRSP) withdrawals are not eligible, so to split RRSP income with a spouse, you need to convert your RRSP to a RRIF. (The full list after age 65 is here.)
Common pensions, like Canada Pension Plan (CPP) and Old Age Security (OAS) are not eligible for pension income-splitting. A CPP retirement pension is eligible for pension sharing (you need to send an application to Service Canada, and you can only split the portion earned during your relationship). You can apply before or after you start to receive benefits to have your pension and your spouse’s pension split equally. This may result in more CPP benefits being payable to the spouse who did not contribute as much to CPP. (See here for more information.)
Unfortunately, for those with U.S. retirement savings, Individual Retirement Accounts (IRAs) are not eligible for pension income splitting regardless of the age of the account holder.
To answer your question about whether it always makes sense to split your pension income, Narayan: It depends.
If your wife has a lower income, it will probably make sense to split some of your eligible pension income with her, up to the 50% allowable transfer. There could be situations when, depending on your respective tax deductions and credits, you may not want to transfer pension income or may not want to transfer the maximum. Tax software, whether professional or retail software, can be used to determine the optimal transfer amount that results in the least combined income tax payable on your incomes.
One example of a situation when splitting pension income with a lower income spouse could trigger more tax payable is if that lower income spouse is receiving OAS and they are subject to a clawback of their pension, but the higher income spouse is not receiving or subject to OAS clawback. The pension recipient’s income could be higher, but the effective tax rate of their lower-income spouse could be higher due to the OAS clawback. In this instance, splitting pension income may increase your combined tax.
Many taxpayers have more ability to control the timing and degree of their tax payable in retirement due to their different sources of potential income. You can only spend your after-tax income, so the tax you pay will have a big impact on your retirement lifestyle and, ultimately, the size of your estate for your beneficiaries.
Pension income splitting is just one tool that is available to retirees to minimize their tax payable.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.
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I love these answers from financial planners on pension splitting, because they never factor in the costs of income-based nursing home care fees later in life versus pension splitting in their answers.
Some provinces charge 80% of your income for nursing home care fees. This is much higher than the marginal tax income tax rate on the higher income spouse if the pension is not split. In that case, it is better not to pension split if the lower-income spouse is in the nursing home and the high-income spouse is living independently or in assisted care. This gives the couple the highest net income.
If the higher-income spouse is in the nursing home, then pension splitting will lower the nursing home fees and taxes for the couple for their highest net income.
For years my wife and I have been paying into a joint bank account and it is fairly sizeable. How and where can we each claim a percentage without receipts ?
We are both in our eighties if that is needed.
I love these scenario based rebutles to jap a F.A based off a “If this, then that.” Mr Smith. Did you provide the info about the income based care facility in question? Is the F.A supposed to know that without being told? The article is generic in nature, and you thew a very specific example to dispute why it isn’t good? Different angles can be taken at every turn of financial planning.
Yes it is very very important to do this splitting income from the highest incom to lowerest it make sense in this manner lowerest income partners need this splitting so both parties will be equally successful our government don’t do much about the lowerest income and its not right even the partner is dead the government should pay other partner more then half splitting from the other partners so the lowers partner won’t have problems in future thanks
When my wife receives income under the split pension on the yearly Income Tax Form.
Can she take the funds transferred to her and invest them in her name?
Due to the large volume of comments we receive, we regret that we are unable to respond directly to each one. We invite you to email your question to [email protected], where it will be considered for a future response by one of our expert columnists. For personal advice, we suggest consulting with your financial institution or a qualified advisor.