I often meet retirees who aren’t fully aware of a valuable tax-saving strategy called pension income splitting. Introduced in 2007, this tool allows retirees to significantly lower their tax bill by sharing pension income between spouses or common-law partners.
Despite its benefits, many retirees either overlook it or don’t take full advantage of what it offers. Let’s break down how it works and how you can use it to keep more money in your pocket.
What is Pension Income Splitting?
Pension income splitting lets one spouse transfer up to 50% of their eligible pension income to their partner for tax purposes. Keep in mind, this is just for tax reporting—there’s no actual transfer of funds. The aim is simple: shift some income from the higher-earning spouse to the lower-earning one to reduce overall taxes.
For example, if one spouse has a larger pension and the other has a smaller income, they can move some of that pension income over, potentially dropping both into lower tax brackets and saving on taxes overall.
Flexibility to Fit Your Situation
What makes pension income splitting especially attractive is the flexibility it offers. You and your spouse can decide how much of the pension income to split each year, and you don’t have to stick with the same amount every year. This means you can adjust how much income is split based on changes in your income, tax brackets, or financial goals.
And what if both spouses receive a pension? No problem—each year, you can decide which spouse benefits most from income splitting, adding another layer of strategy to optimize your tax savings.
Why Pension Income Splitting is a Smart Move
Canada has a progressive tax system, which means higher-income earners pay a higher percentage in taxes. Splitting pension income helps lower the taxable income of the higher-earning spouse and shifts it to the lower-earning spouse, often saving the couple money overall.
But that’s not all—pension income splitting may unlock additional perks like the Pension Income Tax Credit. If the lower-income spouse doesn’t already qualify for this credit, splitting income can make them eligible, potentially reducing their taxes by up to $2,000 a year. For example, if your spouse receives $10,000 in pension income and qualifies for the Pension Income Tax Credit, they could lower their federal taxes by about $300.
Additionally, income splitting can help reduce or avoid clawbacks on Old Age Security (OAS) benefits or the Age Amount Credit, making it a valuable strategy for managing retirement income.
What Income Can Be Split?
Not all pension income qualifies for splitting. The Canada Revenue Agency (CRA) defines “eligible pension income” as income from private pensions, such as pensions from former employers. For retirees aged 65 or older, this also includes income from Registered Retirement Income Funds (RRIFs) and Registered Retirement Savings Plans (RRSPs).
However, some income sources don’t qualify, such as Canada Pension Plan (CPP), Québec Pension Plan (QPP), Old Age Security (OAS) payments, and income from U.S. Individual Retirement Accounts (IRAs). It’s important to know which sources you can split to avoid misunderstandings.
Important Considerations for Eligibility
To take advantage of pension income splitting, you and your spouse must be Canadian residents and must not have lived apart for more than 90 days due to a relationship breakdown. Meeting these basic criteria allows you to tap into this powerful tax-saving strategy.
If you’re worried about the paperwork, tools like TurboTax’s Pension Income Splitting Optimizer can help simplify the process by calculating the optimal income split and ensuring you have everything in place for your tax filing.
What If You’ve Missed Out?
If you’ve missed pension income splitting in previous years, don’t worry—you can still claim those missed opportunities. The CRA allows you to reassess your tax returns for up to three years. This means you can apply for income splitting retroactively, potentially recovering those tax savings from past years.
Talk to a Financial Planner
While pension income splitting offers great potential for tax savings, it’s essential to consider your individual financial situation before diving in. Consulting with a financial planner, especially one who specializes in retirement planning and tax strategies, can help you make informed decisions and maximize your benefits while avoiding potential pitfalls.
Final Thoughts
Pension income splitting is a fantastic tool for Canadian retirees to lower their tax burden and boost their overall financial well-being. With some planning and the right guidance, this strategy can help you keep more of your hard-earned money in retirement. Just be sure to apply it thoughtfully and strategically to get the most out of this tax-saving opportunity.