For the past 10 years, you have been able to “split” up to 50% of your eligible pension income with your spouse or common-law partner for income tax purposes. The amount that you split with your spouse for a particular year is called the “split pension amount”. The mechanics of the pension split are described below.
Benefits of the split
Pension income splitting is advantageous where you are in a higher tax bracket than your spouse in a particular year. That is, your spouse will include the split pension amount in his or her income and you will not include that amount in income. By shifting that amount into your spouse’s lower tax bracket, you will save tax overall as a couple.
Another significant benefit of pension income splitting relates to the pension tax credit. The federal credit is 15% of up to $2,000 of your eligible pension income (the provincial credit rates vary). As discussed below, your spouse may also qualify for the credit if you do the pension income split, which again will result in overall tax savings because you could both claim the credit.
Furthermore, it can be beneficial if you are otherwise subject to the Old Age Security (OAS) clawback tax. Basically, your OAS is clawed back at a rate of 15% of your income over $73,756 (2016 amount). So if your income exceeds that amount, the pension income split will save you some of the OAS clawback. Conversely, if the split puts your spouse over that threshold OAS amount, you will have to take that into account in determining whether there is an overall tax savings.
In a similar vein, the age credit, which is available to anyone who is 65 years of age or older, is reduced once your income is over $35,927 and eliminated when your income reaches $83,427 (2016 amounts). So that is another income threshold to take into account in determining your and your spouse’s tax savings with the pension income split.
Although the above calculations and thresholds may be difficult to work through, pension income split software programs and calculators make the work relatively easy. Most accounting firms have access to these.
Mechanics of the split
The pension income split is done on an annual basis, with the joint election form T1032 filed by you and your spouse in your tax returns for the relevant year. You can elect to split anywhere from 0% to 50% of your eligible pension income each year. But the amount can vary from year to year. For example, you might elect 40% this year, 50% next year, have no election for the following year, and so on.
The eligible pension income that qualifies for the split includes the following:
If you are 65 or over, it includes:
- Pension income from a pension plan annuity;
- Registered retirement savings plan (RRSP) annuity payments;
- Payments from a registered retirement income fund (RRIF);
- Periodic payments from a “money purchase” registered pension plan;
- Pension payments from a pooled registered pension plan;
- Annuity payments out of a deferred profit sharing plan; and
- Certain payments out of retirement compensation arrangement.
If you are under 65, eligible pension income normally only includes item 1) above, i.e. pension plan annuity income. (However, the next five payments also qualify if you are receiving them as a consequence of the death of a former spouse or common-law partner.)
Similar rules apply in terms of your eligibility for the pension credit – that is, the eligibility depends on whether you are at least 65 years old. They also apply to your spouse if you do the pension income split. Effectively, the split pension amount is treated as the type of pension income that it would have been in your hands, and then the credit for your spouse may apply depending on his or her age.
This year, you are 67 years old and receive $60,000 in RRSP annuity payments (not as a consequence of a former spouse’s death). You elect to do a 50% pension income split with your spouse. As a result, your spouse includes $30,000 of that split pension amount in her income and you include the other $30,000.
You will qualify for the pension credit on $2,000 of your remaining pension income because you are over 65.
If your spouse is 65 or over in the year, she will also qualify for the pension credit on $2,000 of the pension income you have transferred to her. However, if she is under 65, she will not get the credit.
Draft legislation released on September 16, 2016 proposes to expand the definition of eligible pension income to include certain retirement benefits received by former members of the armed forces. Specifically, it will include amounts received, subject to a monetary limit determined under defined pension benefit rules, on account of a retirement income security benefit under the Canadian Forces Members and Veterans Re-establishment and Compensation Act. This change, once enacted, will apply to 2015 and subsequent years.
Joint liability for tax
The pension income “split” is somewhat of a misnomer, because the income tax rules do not require that you actually give any of the income to your spouse. In other words, your spouse includes the split pension amount in income, even if he or she does not actually receive any of it.
Your spouse will be liable to pay the tax applicable to that amount. Your spouse can pay the tax out of his or her own resources, or you can pay it. Also, the Income Tax Act provides that you will be jointly and severally liable with your spouse to pay that tax (e.g. in the event that your spouse does not pay the tax). So either way, you and/or your spouse will have to pay any resulting tax.
On a final note, the pension income splitting rules in the Income Tax Act do not apply to government pension payments such as the Canada Pension Plan (CPP), Quebec Pension Plan (QPP) or the OAS.
However, under the CPP legislation (not the Income Tax Act), you and your spouse can elect to pool your CPP payments and share in the pooled amount equally. In contrast to the pension income splitting rules discussed above, you and your spouse will each actually receive your respective shares of the pooled amount. Each of you reports the amount you receive on your income tax return. As with the pension income split, this can result in overall tax savings for most of the same reasons outlined earlier. Similarly, the QPP in Quebec allows sharing between couples.