Pension splitting: planning opportunities

Pension splitting rules may benefit taxpayers, especially those aged 65 or older. Since 2007, a taxpayer who has reported certain income on their tax return has been able to elect to take a deduction for up to 50% of this amount and have his or her spouse (or common-law partner; we’ll refer to both as spouses) report a like amount. The spouses are able to, provided they both reside in Canada at the end of the taxation year.

Unlike CPP sharing (where possible), the income is not split at source. Instead, each taxpayer files CRA Form T1032 – Joint Election to Split Pension Income with his or her tax return. A unique election can be made each year.

Knowing all this, let’s dive into the details.

Advantages of pension splitting

There are three main advantages:

1. Tax rate differentials: If the spouse being allocated the income is in a lower tax bracket, overall income tax savings arise.
2. Eliminating or mitigating the erosion of the age credit: This credit is clawed back once the taxpayer’s net income exceeds a threshold amount ($36,430 for 2017). Allocating income to a spouse may reduce the clawback of this credit. (Again, for provincial tax purposes, the credit amount varies by province.)
3. Eliminating or mitigating OAS clawback: OAS is clawed back once a taxpayer’s income exceeds a threshold ($74,788 for 2017).

What income qualifies for pension income splitting for a recipient aged 65+

Those aged 65 or older on December 31 of a given tax year have the most to gain under these rules. Up to 50% of qualifying income can be allocated to a spouse of any age.

Here are the types of eligible income:

• Life annuities out of or under a superannuation or pension: The amounts may be paid from an Registered Pension Plan (RPP), or may be paid directly by the employer.

• RRIF payments: Taxable RRIF payments to both the annuitant or to another beneficiary, including those from locked-in plans, qualify. (But any portion of the amount that has been rolled over to another RRSP, RRIF or annuity cannot be split.) Also, amounts received on deregistration of a RRIF qualify. Note that RRSP withdrawals are not on the list of qualified items. That’s because lump-sum RRSP withdrawals never qualify for splitting. As noted above, where the 65-year-old wishes to split income from this source, these funds must be transferred to a RRIF, and the withdrawal made from that plan.

• Annuity payments from an RRSP. An RRSP must mature no later than at age 71. Annuity payments made in the year the plan matured or thereafter qualify. (Prior to the advent of RRIFs, an annuity was the only approved method of paying retirement income from an RRSP.) These annuities may be either life annuities or term-certain annuities to age 90.

• Variable pension benefits. The pension-standards legislation of a jurisdiction may permit a defined contribution Registered Pension Plan to make RRIF-like payments. These would qualify.

• Instalment payments under a deferred profit-sharing plan (DPSP). A DPSP must mature no later than the year in which the member turns 71. Where the member chooses the instalment payment approach (with the instalments made over a maximum of 10 years), these payments qualify.

• Prescribed annuities. Non-registered funds may be used to acquire life or term certain annuities. If certain conditions are met, these annuities enjoy beneficial tax treatment. Instead of being taxed on an accrual basis (where the taxable portion is highest in the early years and then declines), they enjoy level taxation. That means the insurance company determines what portion of each payment is taxable; this portion then applies to all payment.

Income that does not qualify for splitting

Certain sources of income cannot be split under these rules. These sources include:

• a pension or a supplement under the Old Age Security Act;
• a benefit under the Canada Pension Plan;
• payments from a retirement compensation arrangement (RCA) with certain exceptions.