Splitting pension income is not a sexy topic. Hardly anyone pays it much mind when discussing retirement planning, taxes or income. But pension splitting is a powerful tool available to Canadian couples to reduce their tax burden in retirement and leave them with more money with which to accomplish their goals.
Income splitting is a fairly straightforward concept. Because we as Canadians are subject to a progressive taxation system, the more money you make, the higher your tax rate. So as your income climbs, your taxes become a higher share of each dollar you earn until you hit the highest marginal tax rate – 53.5% on income over $220,000 in Ontario. If one spouse1 has higher income than the other, you can pay less tax overall by transforming highly-taxed income in the hands of the high earner to lower-taxed income in the low earner’s hands.
Not all types of income can be split. Regular employment income, of course, cannot be split. Dividends and interest income can generally not be split with a spouse , nor can withdrawals from an RRSP – even though they are taxable as regular income. OAS also cannot be split. However, pension income from a defined benefit pension plan can be split, and importantly, so can withdrawals from a RRIF or LIF, provided the withdrawals occur at age 65 or older. CPP can also be split, but according to certain rules based on the length of time the couple has been together, relative to the length of time of CPP contributions.
But how much does splitting income really matter? The answer is: quite a lot. Take the following example of a retired couple, Taylor and Shannon, both aged 75 and having been together since age 20. Taylor has a defined benefit pension plan which pays him $10,000 per year, plus $10,000 CPP and $100,000 of annual RRIF withdrawals. Shannon receives only $5,000 of CPP.
So, in this fairly pedestrian scenario, pension splitting gives this couple over 10% more net family income by reducing the total taxes the family pays. If the disparity between the higher and lower earner was greater, the benefits of splitting would be even more pronounced.
There are other ways to split income which are more complex and go beyond simple splitting of pension income. Self-employed people and those with private corporations can pay a “reasonable wage for services performed” to family members and achieve some measure of income splitting in this manner. Expense management can also achieve a measure of income splitting: having the higher earner pay for all, or a greater share, of expenses, can allow the lower earner to invest more, and pay a lower tax rate on investment income now and down the road. Superficial capital loss rules can also be used to transfer capital losses from a lower earner to a higher earner, for whom the losses have more value2. Spousal RRSPs are also available to reduce income for the higher earner in some scenarios (such as RRIF withdrawals before age 65).
All in all, income splitting is a valuable technique, available to many Canadians, which can have a real impact on their spending ability in retirement. It might have the excitement factor of a club sandwich, but capitalizing on it can improve lives. If you’re interested in learning more, I invite you to visit the new Wealth Management section of our website for new and interesting content posted frequently.
|1Spouse||Gifting securities to a spouse for the purpose of having the spouse pay taxes on dividends and interest, for example, triggers attribution rules which result in the person who gifted the securities remaining liable for paying the taxes.|
|2Value||When you sell a stock at a loss, you’re not able to claim the capital loss if you or a family member re-purchase the same stock within 30 days, which is called a “superficial loss”. Instead, the loss that would have been claimed on the old shares is added to the cost basis of the new shares, resulting in a lower capital gain when (if) the new shares are eventually sold at a profit. Taking advantage of this rule deliberately can allow for moving capital losses from one person to another.|