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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.
A pension income split 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.
To qualify for pension income splitting, you must meet all the following requirements:
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.
You could have a variety of pension income sources as a retired taxpayer, but not all qualify for pension splitting. The income sources deemed eligible for income splitting depends on the two factors: your age and the type of pension income.
Below are some of the types of pension income eligible for splitting:
While all of the above qualify for pension splitting arrangements, there are additional conditions based on whether or not you have reached the age of 65. In general, there are fewer restrictions on pension splitting income sources for those over 65.
For example, if you’re under 65, eligible annuity payments only qualify for pension income splitting if they result from the death of a spouse or common-law partner. If you’re over 65, these same conditions don’t apply.
The following sources of pension income don’t qualify for pension income splitting:
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. The maximum transfer amount permitted is 50% of your eligible pension income. 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.
Here is an example of how pension income splitting works to lower your tax liability:
Suppose you earn $65,000 in retirement income per year, which places you in the 20.5% federal tax bracket. Your spouse earns $20,000 in retirement income per year, which puts them in the 15% federal tax bracket.
Assuming all your retirement income qualifies for pension splitting, you’d be eligible to transfer up to $32,500 to your spouse.
You could elect to transfer $20,000 of your pension income to your spouse, which would reduce your total taxable income to $45,000 and simultaneously increase your spouse’s income to $40,000. Your revised taxable income now puts you in the first federal tax bracket of 15%, while your spouse’s taxable income keeps them in the 15% federal tax bracket. The result is you pay less tax overall as a couple.
Keep in mind 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.
The pension income amount is a federal non-refundable tax credit that allows individuals to claim up to $2,000 of eligible pension income on their tax return. The credit translates to tax savings of $300 ($2,000 multiplied by the federal tax rate of 15%).
The pension income amount is still applicable within a pension income splitting arrangement. If you’re the transferring spouse, the total amount you can claim is the lesser of:
If you’re the receiving spouse, you’ll be able to claim the lesser of:
To calculate the pension income amount for you and your spouse, fill in the required information in Step 4 of Form T1032.
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:
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.
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