Meet early retirees Clara and Charlie, both 63 years old and living in Ontario. Charlie has a $3,200 monthly defined benefit pension through his employer and still does occasional consultation work. In total, he earns about $60,000 annually, which puts him in the 29.65% combined federal and Ontario 2019 marginal tax bracket. Meanwhile, Clara’s work pension amounts to about $2,300 monthly, or $27,600 annually, putting her in a lower (20.5%) tax bracket than Charlie. Now that the couple is generating less income than they did when they were both working fulltime, they’re looking for ways to lower their tax burden to keep as much of their money as possible.
Thanks to Canada’s pension income splitting rules, Clara and Charlie have the potential to reduce their overall income taxes by dividing up the money they receive from their respective pension plans. Based on their age and the eligibility requirements, Charlie can give up to half of his pension income to Clara for tax purposes – in short, because Charlie is in a higher tax bracket, he can split his income with Clara and drop into a lower tax bracket without bumping her to a higher one.
A primer on pension income splitting
Once you understand the age and eligible income rules, taking advantage of pension splitting is as simple as completing a tax form each year. No money has to change hands.
What is pension splitting?
Pension splitting allows a couple to allocate up to 50% of their eligible pension income with their spouse or common-law partner for income tax purposes. To qualify, you and your spouse or partner must both be Canadian residents, be living together at the end of the tax year and remain together for a period of 90 days or more at the beginning of the next tax year.
What qualifies as eligible pension income?
For those under age 65, the most common form of eligible income is from a registered company pension plan, whether defined benefit or defined contribution. Individuals who are age 55 or older are eligible to split pension income with their spouses.
Individuals without a registered pension plan can also take advantage of this tax strategy by converting their Registered Retirement Savings Plans (RRSPs) or deferred profit-sharing plans into income through a life annuity or a Registered Retirement Income Fund (RRIF). It’s important to note, however, that this income doesn’t qualify for splitting until after age 65.
In terms of government pension sources, the Canada Pension Plan (CPP)/Quebec Pension Plan (QPP) isn’t considered eligible income, although CPP/QPP benefits can be split based on a separate set of “sharing” rules. Old Age Security (OAS) payments also aren’t eligible income.
The complete list of eligible pension income sources can be found on the Government of Canada website.
Who should take advantage of pension splitting?
In general, if one of the pension earners is in a higher marginal tax bracket than their spouse, then pension splitting is worth considering.
Take advantage of our retirement planning support
Other potential tax-management strategies related to pension income splitting include the pension tax credit for qualifying individuals. When it comes to planning for retirement, there’s a lot to think about, but we can help.
Learn more about how you can get the most out of your retirement income by contacting one of our Investment Advisors today.
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