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.