Understanding Pension Splitting
Canadian taxpayers can annually elect that up to 50 percent of certain types of pension income can be split, shifted, or allocated from a higher-tax-bracket spouse/common-law partner to a lower-tax-bracket spouse/common-law partner. This results in the couple paying less tax! The tax paid by the lower-tax-bracket spouse/common-law partner will be less than the tax saved by the higher-tax-bracket spouse/common-law partner.
Unlike in CPP (Canada Pension Plan Sharing) sharing, with pension splitting you don’t need to contact the payer of the pension income. The pension can continue to be paid to one spouse and the tax information slip (that is, the T4A, T4RIF) is issued solely to the actual recipient of the pension. No actual payment needs to be made to the other spouse. In other words, in using pension splitting you don’t have to do anything except make a few new notations on tax returns and complete form T1032, Joint Election to Split Pension Income.
The pension-splitting result is optimal when one spouse/common-law partner is in the highest tax bracket and the other spouse/common-law partner is in the lowest tax bracket.
The decrease in the higher-tax-bracket spouse’s/common-law partner’s income could cause his or her OAS (Old Age Security) clawback to be reduced or eliminated (Good news!). The increase in the lower-tax-bracket spouse’s/common-law partner’s income could cause him or her to have an OAS clawback or an increase in the current OAS clawback. (Not so good news!)
Because the lower-tax-bracket spouse/common-law partner will report a higher net income as a result of electing to pension split, the age credit available prior to pension splitting can be reduced or eliminated. (The age credit decreases as income begins to exceed $33,884 in 2012.) As well, the higher-tax-bracket spouse’s/common-law partner’s claim for a spouse or common-law partner amount can be reduced or eliminated.
To decide whether an election to pension split makes sense, weigh these implications in light of the tax savings pension splitting can provide.
Determining whether you qualify for pension splitting
The pension-splitting rules apply to Canadian residents who are married or in a common-law relationship. The maximum amount of eligible pension income that can be split is prorated in cases where a couple comes together during a year or one of the spouses/common-law partners dies.
You can split your pension income with your spouse/common-law partner even if he or she is under the age of 65.
Deciding whether your pension income qualifies for pension splitting
To make use of the pension-splitting rules the pension recipient must receive eligible pension income. To figure out what is eligible pension income it’s easiest first to see what represents ineligible pension income for purposes of pension splitting:
Old Age Security (OAS) payments
Canada or Quebec Pension Plan (CPP/QPP) (other rules apply for sharing these types of income)
Non-annuity registered retirement savings plan (RRSP) withdrawals
Withdrawals from a retirement compensation agreement (RCA)
When the actual pension recipient is age 65 or over at the end of a year, the pension income eligible for splitting includes the following:
Annuity payments from a registered pension plan (RPP)
Annuity payments from a deferred profit sharing plan (DPSP)
Registered retirement income fund (RRIF) and life income fund (LIF) withdrawals.
When the actual pension recipient is under 65 at the end of a year, the pension income eligible for splitting includes the following:
Annuity payments from a registered pension plan (RPP)
Amounts listed above for the 65 or over crowd if received by virtue of the death of a spouse/common-law partner.
Knowing how to pension split
It’s simple! The pension-splitting rules are elective on an annual basis. Follow these steps:
The amount to be split is deducted on line 210 on the tax return of the spouse/common-law partner who actually received the pension — the high-tax-bracket spouse/common-law partner.
The amount is added to the income reported on the other spouse’s/common-law partner’s tax return — the low-tax-bracket spouse/common-law partner — on line 116.
The tax withheld on the actual pension payments to the high-tax-bracket spouse/common-law partner is allocated to the other spouse/common-law partner on the same basis as the pension income was split. (This removes the cash-flow burden of requiring the low-tax-bracket spouse/common-law partner to come up with a significant amount of tax money on April 30!)
Both spouses/common-law partners must agree to partake in pension splitting and the amount to be split, and must complete and sign two copies of form T1032, Joint Election to Split Pension Income. Each spouse/common-law partner must include the form with their tax return if paper filing. If electronically filing each spouse/common-law partner needs to keep a copy in case the CRA asks to see it.
Claiming an extra pension income credit
The rules for the pension income credit were expanded when the pension-splitting rules came into being back in 2007. If both spouses/common-law partners are over age 65, then each will be able to claim up to a $2,000 pension income credit amount. (If the eligible pension income is less than $2,000 the credit maxes out at the actual eligible pension income taxed to each spouse/common-law partner.) The result is that pension splitting may serve to permit another pension income credit amount of $2,000 in the family where the lower-tax-bracket spouse/common-law partner was not entitled to it previously.
The rules are a bit trickier if both spouses/common-law partners aren’t over age 65. In that case, if the payments came from a registered pension plan (RPP) then each spouse/common-law partner is entitled to a pension credit regardless of age. However, in most circumstances payments from an RRSP or RRIF will not qualify for the pension credit in the hands of a spouse/common-law partner under age 65. In that situation, you may still benefit from paying less tax if each spouse/common-law partner is in a different tax bracket — you just won’t benefit from the pension credit as well.