Pension Income Splitting in Canada

Pension income splitting is a legal way for seniors in Canada to lessen their tax load.

They can save significantly on taxes by dividing their qualifying retirement money with their spouse or common-law partner, especially if their partner is in a lower tax bracket. It's a strategy you can use to positively shape your retirement.

Let's cover how this works in more detail.

What is Pension Income Splitting?

Pension splitting allows you to share up to 50% of your pension income with your spouse, if you are eligible, for tax purposes.

With pension income splitting, couples can shift a portion of the higher-earning spouse's pension income to a lower-income partner. This reduces the overall tax burden on their household.

Only one joint election for pension income splitting can be made for a given tax year, and both spouses or common-law partners must meet all eligibility requirements set forth by the Canada Revenue Agency (CRA).

Eligibility Criteria for Pension Splitting

The Canada Revenue Agency (CRA) has specific requirements that both individuals must meet to qualify for pension income splitting.

The eligibility factors to consider are:

1. Residency and Living Arrangements

Both individuals who wish to split their pension income must be residents of Canada. This means they should have a primary residential tie to Canada and spend at least 183 days in the country each tax year. Additionally, they must be residents and live together at the end of the tax year and for 90 days or more at the beginning of the next year.

2. Relationship Status

To be eligible for pension income splitting, the couple must not be involved in a separation or divorce. The CRA must legally recognize both individuals as a couple for income tax.

3. Type of retirement income

It's important to note that while some forms of retirement income may be eligible for pension splitting, others may not qualify. Eligible pension income includes registered company pension plans, converted RRSPs, or deferred profit-sharing plans into income.

However, it excludes government pension sources like Canada Pension Plan (CPP)/Quebec Pension Plan (QPP) or Old Age Security (OAS) payments.

The eligibility criteria set by the CRA are designed to ensure that pension income splitting is carried out within the parameters of Canadian tax laws. Getting independent professional advice based on your circumstances is important to ensure you comply with these criteria and make informed decisions regarding pension income splitting.

What can be split?

Regarding splitting pension income in Canada, not all incomes are eligible. Only specific types of retirement income can be allocated between spouses or common-law partners.

The eligible types of income that can be split include:

1. Annuity payments from a superannuation or pension plan,
2. Registered Retirement Income Fund (RRIF) payments and
3. Certain annuity income.

Not all types of annuity income are eligible for splitting. You should review the available income sources carefully when developing a strategy for pension income splitting.

By identifying and understanding which types of retirement income are eligible for splitting, couples can make informed decisions about maximizing the benefits of pension income splitting to support their financial goals and overall retirement plan.

Advantages of Splitting Pension Income

Pension income splitting isn't just a paperwork exercise; it can significantly impact the financial well-being of Canadian retirees in multiple ways.

Lowering Overall Tax Liability

It all starts with taxes - by redistributing income, pension income splitting can move a couple's combined income into a lower tax bracket, thereby reducing their overall tax liability. This means more money stays in the pockets of retirees rather than going to the government in taxes, allowing them to maintain a higher standard of living during retirement and potentially leaving them with more disposable income for necessities and leisure activities.

Enhancing Retirement Income Security

Efficient tax planning through pension income splitting allows retirees to manage their tax obligations strategically, maximizing their retirement income. By optimizing tax-saving opportunities, couples can ensure they have more available funds to support their lifestyle during retirement. This is vital in establishing long-term financial security and stability, providing peace of mind as they navigate their post-career years.

Equalizing Income Between Spouses

For couples with a significant difference in income levels, pension splitting can help bridge this gap. Balancing the taxable income between partners ensures fairer taxation for both individuals. As a result, it facilitates financial equality within the household, promoting stronger financial stability and harmony throughout retirement.

Disadvantages of Splitting Pension Income

Impact on government benefits

Pension income splitting has its perks, but it's not without its downsides. One notable consideration is how it can impact your eligibility for certain government benefits or credits based on income.

For instance, certain programs, such as the Guaranteed Income Supplement (GIS) for low-income seniors, and other benefits like the Goods and Services Tax/Harmonized Sales Tax (GST/HST) credit and provincial social assistance, are calculated based on individual income thresholds. When you split your pension income with your spouse, you may have less income individually, which could negatively impact your eligibility for these benefits.

Changes in legislature

Another hidden disadvantage to remember is the future legislative changes that could potentially tamper with the current landscape of pension income splitting. Tax laws and regulations are subject to change over time, meaning that the advantages you're leveraging today might be altered down the line.

For example, the Tax Court of Canada decision in 2013 clarified that RRSP withdrawals do not qualify as pension income eligible for splitting today. The court suggested that converting an RRSP to an RRIF before withdrawing would make them eligible for pension splitting. This change underscores the importance of updating yourself with legislative developments to ensure your financial plans remain optimized and effective.

Encountering some barriers to pension income splitting shouldn't deter you from its benefits but rather encourage you to approach this strategy holistically and carefully.

Start your Pension Income Splitting Journey

To begin your pension income-splitting journey, it's crucial to consult with a financial advisor or tax professional. This step allows you to assess your specific circumstances and understand the potential benefits of this strategy. Each person's financial situation is unique, and seeking professional advice will help determine if pension income splitting suits you.

Your financial advisor can provide valuable insights into the tax implications and financial impact of pension income splitting. They can guide you through the eligibility requirements, the process of making joint elections, and the potential tax savings involved. By seeking professional advice, you can make well-informed decisions that align with your retirement goals and financial plans.

Conclusion

While splitting pension income offers immediate tax advantages by reducing taxes in the current year, it could potentially conflict with your long-term tax planning objectives. It's all about finding the right balance between immediate tax benefits and long-term financial planning while being mindful of potential government benefits eligibility changes due to income redistribution.

Suppose you and your spouse are eligible for pension income splitting. In that case, your financial advisor can help you analyze how much income should be allocated to maximize tax benefits for both partners. They can also assist in understanding any limitations or constraints regarding eligible pension income, enabling you to make strategic decisions that optimize the potential advantages of this approach.

In addition to exploring pension income splitting, it may also be beneficial to consider the role of life insurance in securing retirement finances. Life insurance company products and strategies can complement your retirement security plan by offering financial protection and additional avenues for wealth accumulation.

When considering life insurance options, individuals may find valuable resources and guidance at Dundas Life, a reputable life insurance brokerage known for providing tailored solutions to bolster retirement security. Schedule a consultation with Dundas Life today to explore personalized life insurance solutions tailored to your needs.