Are advisors pushing the envelope on pension splitting?
Pension splitting continues to save married and common-law couples thousands of dollars each year. The savings come not just from shifting pension income from a higher tax bracket spouse or partner to a lower-bracket spouse or partner’s hands but also by preserving Old Age Security benefits otherwise clawed back and, in some cases, doubling the pension income credit and restoring some of the age credit.
As planning for pension splitting is becoming more entrenched in advisors’ toolboxes, some advisors are getting creative – at least in the types of scenarios being proposed to the Canada Revenue Agency’s Income Tax Rulings Division.
Here are a few “interesting” technical interpretations released in the past year surrounding pension income splitting.
Splitting and spousal attribution
The first technical interpretation (2007-0257001E5), admittedly one which I personally submitted along with my former colleagues, involved a hypothetical situation in which a husband contributed to his wife’s spousal RRSP. Both are over 65 such a RRIF withdrawal by either would qualify for pension splitting.
The wife converts her spousal RRSP to a RRIF and immediately withdraws the funds. Under the three-year attribution rule for RRSP/RRIF withdrawals, the amount withdrawn would be included in the husband’s income.
The question we posed to the CRA was whether that attributed RRIF withdrawal would be eligible for the pension income credit as well as pension splitting.
The CRA responded that "eligible pension income" for someone at least 65 includes “any pension income received by the individual in the year out of or under a registered retirement income fund.” Since the reverse attribution rule operates to include the amount withdrawn in a contributing spouse's income, the amount is therefore not a “payment out of or under a RRIF that is received by the contributor.” As a result, the amount withdrawn would not be considered to be pension income and is therefore not eligible for either the pension credit or pension splitting.
In addition, the wife also couldn’t claim the pension credit or split the withdrawn RRIF amount since the definition of pension income in the Income Tax Act does not include an amount that was deducted from income.
Since in our case the wife can deduct the RRIF withdrawal attributed back to her husband (a rule instituted to avoid the double taxation of the same amount), there is no net amount included in the wife’s income for purpose of the credit or pension splitting.
Splitting, attribution and annuity income
The second technical interpretation (2008-0284411C6) involved a situation in which Mr. A, who is 66 years old transfers $100,000 to his spouse who is 63 years old and she purchases a prescribed life annuity contract on her life.
Under the normal attribution rules, the taxable portion of the annuity payments will be taxable back to Mr. A. The question posed to the CRA was whether the taxable portion of the annuity payments, which have been attributed back to Mr. A, qualify as "eligible pension income" for him and is therefore eligible for pension splitting.
The CRA responded that while normally, the taxable portion of an annuity is considered to be pension income for someone over 65, in this case it’s the attribution rule itself that is causing the amount to be included in Mr. A’s income and thus technically, would not constitute pension income for Mr. A.
Splitting in year of death
The Canada Revenue Agency was asked last fall (2008-0275731E5) whether pension income could be split even if one of the spouses died during the year.
In the situation described, the deceased's spouse, Eve, received pension income during the taxation year in which her husband, Adam, died. Adam’s executor and Eve would like to split the pension income received by Eve between her and her late husband.
The CRA responded that this was indeed possible but the maximum amount that could be split would be 50% of the eligible pension income prorated by “the number of months at any time during which…(Eve)…was married…to Adam.”
Perhaps overstating the obvious, the CRA explains that since Eve “will not be considered to be married to (Adam) after his death…the maximum that (Eve) will be allowed to split with (Adam) will represent only a portion of the (otherwise)…eligible pension income.”
So, if Adam had died in February 2009, the maximum amount eligible to be split would be 2/12 of 50% of the eligible pension income since Adam and Eve were married for two months in 2009. (Partial months count!)
This split-pension income must be included in Adam’s final tax return and Adam’s executor and Eve will have to complete and sign Form T1032 to elect to split the eligible pension income and file that Form with each of Adam and Eve’s tax returns for 2009.