Pension Income Splitting: How it can lower your tax bill

Older couple doing taxes together

Pension splitting in Canada can be an extremely effective way for couples to minimize their income tax and maximize their retirement income. In this article we’ll cover all you’ll need to know to reduce your taxes through pension income splitting.

We’ll look at the differences between pension income splitting under 65 and over 65 and explore the CRA pension income splitting rules. We’ll also dive into the advantages and disadvantages of pension income splitting in Canada.  

What is pension income splitting?

Pension splitting in Canada is a legal way for retired couples to considerably reduce their overall tax bill. It involves moving income from the highest-earning person to the lowest-earning person.

For example, a retiree earning $80,000 per year would be paying a much higher tax rate than their spouse earning $10,000 per year. However, a pension split could bring the highest earner’s income down to $45,000 (which would raise their spouse’s income to $45,000), whereby lowering their collective taxes by thousands of dollars.

How much pension income can be split?

Pension splitting in Canada allows you to split up to half of eligible retirement income with your spouse. To be able to split pension income, you must have a spouse who is classed as either your husband, wife or common-law partner, you must be living together on December 31 of the year in which you plan on pension splitting, and you must live in Canada.  

CRA pension income splitting in Canada is reserved for eligible income only, which includes company pension plans and income from Registered Retirement Income Funds (RRIFs) and annuities that have been funded by a Registered Retirement Savings Plan (RRSP). We’ll cover eligible pension income more thoroughly in a later section.

Another advantage of pension splitting in Canada is that it can also prevent the Old Age Security (OAS) Clawback. Any retirees who earn more than the OAS income threshold could have to pay back some or all of their OAS income. By using pension splitting, the highest earning spouse could see their total income fall below the OAS income threshold and therefore hold on to all of their OAS payments.

Pension splitting in Canada can also help both spouses to benefit from the pension income tax credit. To qualify for this, you need to have eligible retirement income, which can be achieved when you split pension income. If one spouse doesn’t have any eligible pension income, the income earning spouse can pension split so they can also receive this $2,000 tax credit, which effectively doubles the tax benefit for the couple.

How to split pension income in Canada

Your accountant or tax advisor should be able to help you to file the necessary forms to allow for pension splitting. If you want to do this yourself, you would need to fill in and submit form T1032 along with your tax returns.

Pros and cons of pension income splitting

Benefits of pension income splitting

As with most tax-saving strategies, there are pros and cons of pension income splitting. Here are the key advantages:

  • You may be able to reduce your joint tax bill by thousands of dollars.
  • You could avoid having to pay OAS clawback.
  • It can allow both spouses to take advantage of the $2,000 pension tax credit.

Disadvantages of pension income splitting

These are the key disadvantages of pension income splitting:

  • Pension splitting in Canada is only available to couples: single people cannot use this strategy.
  • You can’t pension split RRSP lump-sum withdrawals or tax-free foreign pension income.

Pension income splitting example

Let’s look at an example of how to split pension income in Canada.

Elaine, 65, and Roger, 68, live in Beamsville Ontario and are both retired. Elaine has a good company pension that brings in an annual income of $96,000. Roger transferred his RRSP savings into a Registered Retirement Income Fund and receives $22,000 per year from that.

Currently, Elaine pays $20,309 in income tax, while Roger pays $783, making a total annual tax bill for the two of them of $21,092. Elaine’s income is $9,088 above the OAS recovery tax limit, so she has to pay $1,363 annually in OAS clawback. This makes the couple’s combined income tax and OAS clawback tax a total of $22,455.

Elaine’s income is eligible for pension income splitting: she can split up to 50% of her income with Roger but decides to split $37,000 with him so that they both have a taxable income of $59,000. This brings Elaine’s income below the OAS clawback threshold, so she saves $1,363 annually.

Roger and Elaine now both pay tax of $9,178, making the couple’s combined income tax $18,356, which gives them annual tax and OAS clawback savings of $4,099.*  

What is eligible for pension income splitting?

The eligible income sources vary depending on whether you’re pension income splitting under 65 years of age or over 65. You can pension split more types of income when you are aged 65 and over including:

  • Life annuity payments from an RSP, RRSP, deferred profit-sharing plan or retirement compensation agreement.
  • Income from a RRIF, life income fund, locked-in retirement income fund or prescribed retirement income fund.
  • Interest from a life annuity and guaranteed interest contract from an insurance company (from a non-registered account).
  • The taxable part of foreign pension income.

Do both spouses have to be 65 to split pension income

No, just the spouse who is directly receiving pension income needs to be over 65.

When you’re pension income splitting before age 65 in Canada, there are fewer options available:

  • An employer-sponsored registered pension plan (though you have to be over 65 to pensions split this income in Quebec).
  • The taxable part of foreign pension income.
  • If one spouse has died during the year, you can split income from their annuity, RRIF, deferred profit-sharing plan and variable pension benefits.

Who is eligible for pension income splitting?

Married or common-law couples living in Canada are eligible for income splitting if one of them has eligible income. Common-law spouses, as defined by the Income Tax Act, are two people who have been living together in a conjugal relationship for at least 12 continuous months.

Also, both spouses must be resident in Canada on December 31 of the year in which you want to pension split.

Can you pension split in the year of death of one spouse?

 Certain retirement income can be split in the year that one of the spouses dies. See the section above on eligible income for pension income splitting before age 65 in Canada and over 65 (because there are different rules for different age groups).

Access the value of your home. No monthly mortgage payments required.

Enhance your retirement strategy

For many retirees, making the most of every dollar of their retirement income can be the difference between having a comfortable retirement and scraping by.

Obviously, saving as much as you can for your retirement is one way of ensuring a more comfortable retirement, but once you’ve retired, what can you do to maximize your income?

If your pension income isn’t enough to give you a comfortable retirement, even after pension splitting, there is a very effective way that you can boost your retirement income.

Canadian homeowners aged 55-plus can cash in up to 55% of their home’s value with a reverse mortgage. Like a regular mortgage, a reverse mortgage is a loan secured against your home, but it has some unique advantages for retirees:

  • You can cash in your home equity either in a lump sum or in monthly payments, which can give your retirement income a significant boost.
  • You don’t have to make any mortgage payments: you only pay back what you owe when you sell your home or move out.
  • Because there are no mortgage payments to make, you won’t lose your home through defaulting on mortgage payments.
  • A reverse mortgage is typically easier to qualify for than a regular mortgage or home equity line of credit.

You can find out how much you could qualify for with a CHIP Reverse Mortgage by calling us at 1-866-522-2447 or by using our reverse mortgage calculator.

* Calculations are approximate and for illustration purposes only.

Related Post