A splitting headache over pensions; A Primer
Judging by the volume of questions I get on the subject, it's clear that the ability to split pension income, while perhaps one of the biggest tax-savings changes in some time, still has Canadians scratching their heads about how it works. So, herewith, a primer on the new pension-splitting rules:
What is pension splitting? Beginning with the 2007 tax return, Canadians are able to split up to half their pension income by allocating it to a spouse or common-law partner. Who should do it? If your partner is in a lower tax bracket, pension splitting is a smart way to offload income from the higher-earning partner, who pays higher taxes.
What pension income is eligible for the split? Any pension income that qualifies for the $2,000 federal pension income credit also qualifies to be split. Specifically, this would include annuity-type pension payments from a pension plan (regardless of your age) and, once you reach age 65, can also include RRIF or life income fund (LIF) withdrawals.
Under the legislation, Old Age Security (OAS) payments and Canada or Quebec Pension Plan payments do not qualify since they also do not qualify for the pension income credit. (CPP/QPP can already be split under separate legislation.)
What if tax is withheld? The rules state that any tax withheld at source from pension income must be allocated between partners in exactly the same proportion as the pension income was split.
Who can claim the $2,000 pension income credit? Both the recipient partner and the transferee partner may each potentially claim the $2,000 pension credit. While the transferor partner will obviously qualify for the credit since he or she has received pension income, the rules for the recipient partner get a little trickier. Eligibility for the credit can also depend on the age of the recipient.
For example, say Harvey, age 65, decides to split his RRIF withdrawals with his wife, Lisa, who is only 62. While Harvey is eligible for the pension income credit resulting from his RRIF withdrawals, the allocated amount won't qualify for a credit in Lisa's hands since she is not yet 65 years of age.
On the other hand, if Harvey was receiving a monthly income from a pension plan, the income would automatically qualify for the pension credit in both Harvey and Lisa's hands, regardless of their ages. That's because it's an annuity-type pension as opposed to a RRIF withdrawal. How much tax can I actually save? Of course, the amount you ultimately save will depend on your personal tax situation and that of your partner. But keep in mind that in addition to the income tax savings and possible doubling of the pension income credit, you may also be able to preserve some of the age credit, which is available to those from the age of 65, but reduced at income levels between $30,936 and $65,449. Likewise, you may also avoid a "clawback" of Old Age Security benefits, which begins to be reduced at income above $63,511.
Next week, we'll look at the math and show how pension splitting can lead to thousands of dollars in tax and Old Age Security savings.