Canadians have been handed a wonderful Christmas gift, yet most of us don’t realize it yet. We’ve been so busy reviling Finance Minister Jim Flaherty for his new tax on income trusts that we still haven’t unwrapped all the other tidbits that came with the trust announcement. The most important is called pension income splitting and it’s potentially a much bigger deal than all the outraged headlines about income trusts combined.
Income splitting could put thousands of extra dollars in your pocket every year, and maybe even allow you to retire earlier. “At some point just about all of us will be affected by this,” says Sandy Cardy, senior vice president of tax and estate planning at Mackenzie Financial in Toronto. “Most people are focusing on the trusts, but for many Canadians, pension splitting is going to have a much bigger impact.”
How big an impact? If you’re married and one of you gets $70,000 a year from a pension, you could get an after-tax raise of more than $5,000 a year starting in January. If you’re not retired this affects you too at least if you want that extra cash when you do retire.
The new rules allow you to reduce your taxes by spreading your family’s pension income more evenly between you and your spouse. For instance, if you get an annual $70,000 pension and your spouse has no income, you could split up to half of your pension with your husband or wife, and fill out your tax returns as if you each earned $35,000 a year. Your combined income hasn’t changed, but you’ll pay far less tax because you’re now in a lower tax bracket.
What if I’m still saving for retirement?
Then it’s time to change your retirement plan to maximize your eligible pension income, because that’s pretty much the only type of income you can split. While you’re under 65, only income from a registered pension plan, like a pension from work, qualifies. When you hit 65, then you can also split income from your RRSP by converting it to an RRIF or annuity.
To maximize your pension income, you should join your company pension plan if there is one, and keep as much of your retirement savings in an RRSP as you can, even if that means forgoing the lower tax rates on capital gains and dividends. “That’s because the tax you save by income splitting could more than offset that,” says Cardy. Of course, you’ll see the biggest impact if you have a spouse who makesconsiderably more or less money than you do. If you’re single, you’re out of luck.
Could I retire a year earlier?
In some cases, yes. Consider the $5,000 a year you would gain from pension splitting in the example above. If you’re a 65-year-old male, that $5,000-a-year gain for life is equivalent to a $67,000 annuity. With income splitting, you can save that $67,000 and use it to fund an extra year of retirement.
Could I keep my OAS from getting clawed back?
Definitely. If you expect your retirement income to be greater than about $62,000, the government will claw back some of your Old Age Security payments, which could cost you up to about $6,000 a year. Lowering your income by splitting it with your spouse means you’ll pay less tax and get more of your OAS.
Malcolm Hamilton, an actuary with Mercer Human Resource Consulting in Toronto, says planners are just starting to appreciate the wide-ranging implications. He expects some people with good pension plans will start retiring earlier so they can split their incomes, and work part time until 65. He also expects more couples will start converting their RRSPs to RRIFs right at 65 rather than waiting until they’re 69. Cardy adds that you can fine tune your net income year by year. For instance, you might want to lower your income one year to claim more medical expenses or pay less tax on dividend income, then lower your spouse’s income the next.
How much will you save?
These couples will save thousands. You could too.
Rosco and Virginia are 62 and retired. Rosco has no income;
Virginia has a $50,000-a-year pension. She can split her income 50-50
with Rosco even though she’s under 65, because it’s pension income.
Combined after-tax income before splitting: $39,800
Combined after-tax income after splitting: $43,100
Income boost: $3,300 a year
Tom and Nicole are 64. Tom has a $70,000 pension and Nicole
has no income. Otherwise, they’re in the same position as Rosco and Virginia.
Combined after-tax income before splitting: $53,400
Combined after-tax income after splitting: $58,800
Income boost: $5,400 a year
Bob and Margaret are 67 and have applied for OAS. Bob receives
$60,000 a year from his RRIF, $30,000 from consulting work, and $10,000 from
CPP. Because his income is high, all of Bob’s OAS is clawed back. By splitting
his RRIF income with Margaret, Bob pays less tax, and gets most of his OAS back.
Combined after-tax income before splitting: $76,500
Combined after-tax income after splitting: $85,900
Income boost: $9,400 a year
All figures are approximate and assume Ontario residency. CPP sharing and other credits and reductions, such as the age amount, were not taken into account.