Problems with pension splitting

Advisor's Edge

2013-09-17



Pension splitting allows someone to split up to half of her pension income with a spouse or partner. This can result in substantial tax savings if one spouse is in a lower tax bracket. Pension splitting can also preserve OAS benefits, which might be clawed back if the recipient partner’s income is above the clawback threshold.

What type of income qualifies to be split? Generally, any pension income that qualifies for the $2,000 federal pension income credit. This would include annuity-type pension payments from a pension plan (regardless of age) and, once your client reaches age 65,RRIF or Life Income Fund (LIF) withdrawals.

It does not, however, include RRSP withdrawals. This last point was the subject of a recent Tax Court of Canada decision (Tremblay v The Queen, 2013 TCC 186) released in June. Paul Tremblay appealed his 2009 and 2010 tax assessments. When he filed his 2009 and 2010 tax returns, he and his spouse jointly elected to transfer half his RRSP withdrawals to her in each of the two years. He moved $4,523.40 in 2009 and $7,219.81 in 2010. CRA reassessed Tremblay and denied the pension income transfers in both years.

The funds came from a self-directed RRSP, established in 1994, that had been invested in a variety of GICs for various terms at various interest rates.

Tremblay’s position was that these GICs “are actually annuities that he bought through his self-directed RRSP and that the amounts withdrawn from his RRSP are thus eligible to be split with his wife as pension income.” He even referred to the GICs as annuity certificates on the basis that the interest on them was payable annually.

Unfortunately, Tremblay’s RRSP withdrawals did not qualify under the Income Tax Act’s definition of pension income. The Income Tax Act’s wording is particular, and qualifying amounts for someone who’s reached age 65 include:

•a payment in respect of a life annuity out of or under a superannuation plan;
•a payment in respect of a pension plan or a specified pension plan;
•an annuity payment under an RRSP; and
•a payment out of or under a RRIF.

The Tax Court judge concluded the withdrawals made by Tremblay from his self-directed RRSP do “not constitute any type of payment provided for in the definition.” The court suggested that had Tremblay converted his RRSP to a RRIF, since he was 65 years of age, the withdrawals could then have been considered pension income eligible to be split with his spouse. Yet the evidence showed he didn’t want to convert the RRSP into a RRIF as “he intended to use the funds for things like travel.”

Finally, the judge addressed Tremblay’s annuity argument, saying the type of investments inside the RRSP is irrelevant. Rather, in determining whether or not an “annuity payment under an RRSP” has been made, you need to look at the situation after the money is withdrawn from the RRSP, not before.

If Tremblay had used his RRSP funds to purchase a registered annuity or a RRIF, then the subsequent withdrawals would have been qualified as pension income and been eligible to be split.

This is an important distinction we should remind our clients about. In other words, if a client is 65 and wants to pension split, he or she should first convert an RRSP to a registered annuity or RRIF before withdrawing funds.