When it comes to taxes, most people are preoccupied with one question: how can I pay less?
An abundance of credits and deductions are available in the Canadian tax code, all of which provide a way for individuals to reduce their tax burden. Numerous strategies can also be employed to minimize one’s tax burden further. One of these strategies is pension income splitting.
Key Points You Should Know
- Pension income splitting allows you to share your income with your spouse or partner. This lowers your income tax bracket, thereby reducing the amount of taxes you have to pay.
- The maximum amount you can split your income with your partner is 50% of your eligible pension income.
- To split your income, fill out form T10321 Joint Election to Split Pension Income when you file your tax returns.
What Is Pension Income Splitting?
Pension income splitting allows you to transfer a portion of your eligible pension income to your spouse or common-law partner. In a pension income split arrangement, there is a transferring spouse and a receiving spouse.
Generally, the transferring spouse is in a higher tax bracket than the receiving spouse. Moving a portion of pension income to the spouse in the lower tax bracket allows a couple to take advantage of tax savings.
How Will Pension Income Splitting Reduce My Taxes?
Here’s a step-by-step breakdown of how pension income splitting can reduce taxes:
- Assess Your Retirement Incomes:
- You earn $65,000 in retirement income, placing you in the 20.5% federal tax bracket.
- Your spouse earns $20,000 in retirement income, placing them in the 15% federal tax bracket.
- Determine Eligibility for Pension Splitting:
- Assume all your retirement income qualifies for pension income splitting.
- You can transfer up to 50% of your pension income to your spouse. In this case, up to $32,500.
- Decide on the Amount to Transfer:
- Choose to transfer $20,000 of your pension income to your spouse.
- Calculate Adjusted Taxable Incomes:
- Your taxable income decreases to $45,000 after the transfer.
- Your spouse’s taxable income increases to $40,000.
- Assess New Tax Brackets:
- Your revised income of $45,000 now falls into the lower federal tax bracket of 15%.
- Your spouse’s increased income of $40,000 keeps them in the 15% federal tax bracket.
- Evaluate Tax Savings:
- By splitting pension income, both you and your spouse are taxed at a lower rate (15%).
- This results in a lower combined tax liability, saving money for your household overall.
As seen above, pension income splitting effectively redistributes income between spouses to take advantage of lower tax rates, ultimately reducing the overall net tax burden for the couple.
Note: The example above doesn’t take into account non-eligible pension income such as CPP and OAS, which you’ll need to factor into the calculation.
Do You Qualify For Pension Income Splitting In Canada?
To qualify for pension income splitting, you must meet all the following requirements:
- You were living together with your spouse or common-law partner at the end of the last tax year and have not lived apart for more than 90 days since then.
- You and your spouse or common-law partner were residents of Canada at the end of the last calendar year.
- You were the recipient of a pension income eligible for the pension income amount or were at least 65 years of age and received qualifying income from a retirement compensation plan.
If you and your spouse or common-law partner lived apart for medical, work, or school-related reasons, you still qualify for pension splitting. Only separate living arrangements due to a marriage or relationship breakdown would disqualify you.
What Types Of Pension Qualify For Income Splitting?
You could have a variety of pension income sources as a retired taxpayer, but not all may qualify for pension splitting. The income sources eligible for splitting depend on two factors: your age and the type of pension income.
Below are some of the types of pension income eligible for splitting:
- Regular annuities and income-averaging annuity contracts (IAAC)
- Annuity payments from a Deferred Profit Sharing Plan (DPSP)
- Income from Registered Pension Plans (RPP)
- Income from Registered Retirement Income Funds (RRIF)
- Annuity payments from a Registered Retirement Savings Plan (RRSP)
- Payments from Variable Pension Benefits (VPB)
- Payments from Equivalent Pension Benefits (EPB)
- Payments from foreign pension plans (with some restrictions)
While all of the above qualify for pension splitting arrangements, there may be additional conditions depending on whether or not you have reached the age of 65.
Common Sources Of Pension That Don’t Qualify For Income Splitting
The following sources of pension income don’t qualify for pension income splitting:
- Canada Pension Plan (CPP) benefits
- Quebec Pension Plan (QPP) benefits
- Old Age Security (OAS) benefits
- RRSP withdrawals
- Transferred RRIF amounts.
- Lump-sum pension payments.
- Foreign pension payments.
- Non-registered pension plans.
How Do You Split Your Pension Income?
To split your income with your spouse, you must:
- Complete form T10321 Joint Election to Split Pension Income when you file your tax returns. On this form, you’ll specify who will be the transferring spouse and who will be the receiving spouse.
- You’ll also need to state the amount of pension income you’re transferring. You must record the amount you’re transferring on Line 21000 on your return. Your spouse must record this same amount on Line 11600 on their return.
- Both you and your spouse need to sign the form and attach it to your tax returns. Ensure that the information on both forms is identical before doing so.
How Much Can You Transfer To Your Spouse Or Partner?
The maximum transfer amount permitted is 50% of your eligible pension income.
Can I Split My Income For A Previous Year?
The CRA permits you to file a late or amended election to split your income with your spouse in an earlier year. You can also revoke a previous election. The process involves adjusting your prior tax returns and is allowed if you meet these conditions:
- You must make this election or revocation no later than three calendar years following the original tax filing deadline for the year to which the election applies.
- Both you and your spouse jointly agree to the amendment or late filing.
- Both you and your spouse complete and sign a new Form T1032.
- In the case of an election revocation, you and your spouse send a jointly signed letter to the CRA requesting the cancellation.
The Bottom Line
Pension income splitting can be a valuable strategy to minimize the tax obligations of you and your spouse. Keep in mind, though, that it yields the most benefits when the disparity between spouses’ income is substantial.
Ensure you understand the rules surrounding the eligibility of income sources, the impact of your age, and other crucial qualifying criteria before you utilize pension income splitting. Implementing the strategy is as simple as using specialized tax software to do all the number-crunching, saving you time and effort while realizing easy tax savings
