Pension Income Splitting
Income splitting allows taxpayers to lower their income and in turn, their tax payable.
It means if one spouse earns $60,000 and splits their income with their spouse or common-law partner, they will pay tax on $30,000 each, rather than $60,000. Tax rates increase depending on your income level so the lower the income, the less tax payable. However, the Tax Act only allows income splitting under very specific circumstances. For most taxpayers, this is not an option.
Beginning in 2007, the Federal Government began allowing seniors to split certain pension income. Only certain types of pension income are allowed to be split up to 50 percent of the income between a spouse or common-law partner. Qualifying pension income includes periodic pensions and superannuation payments, foreign pension excluding income from a U.S. Individual Retirement Account and annuities. It does not include lump sum payments, excess amounts from a Registered Retirement Income Fund (RRIF), retirement allowances, death benefits, Old Age Security (OAS) or Canada Pension Plan (CPP) benefits.
To split eligible pension income, both spouses or common-law partners must complete Form T1032, Joint Election to Split Pension Income and attach the form to their income tax returns. Taxpayers who file electronically should maintain a copy of the completed forms in case the Canada Revenue Agency (CRA) asks for them.
Benefits of Pension Income Splitting
The two most obvious benefits of splitting pension income are:
- the transferee will be able to claim the pension income amount on the transferred amount. This is a benefit if the transferee does not already have $2,000 or more of eligible pension income.
- if the transferor is in a higher tax bracket than the transferee, the splitting of pension income has the potential to reduce the family’s overall tax liability by reducing the amount of income that is taxed at the higher rate.
In addition, splitting of pension income has the potential to:
- reduce the amount of the transferor’s OAS clawback as it reduces the transferor’s net income, and
- increase the age amount for the transferor because it reduces the transferor’s net income.
Drawbacks of Pension Income Splitting
Though many older taxpayers can benefit from income splitting, there can be negative effects such as:
- If income is transferred from the lower-income spouse to the higher, the overall tax bill may be increased.
- The transferee’s OAS clawback may be increased by the transfer as their net income is increased.
- The transferee’s age amount may be reduced as their net income is increased.
- If the transferee’s income is low, the transfer may reduce or eliminate the spouse or common-law partner amount.
It is important to review your tax situation before opting to split eligible pension income. The goal is to maximize the benefits and minimize the negative effects.