This is the third post of Jonathan Chevreau’s new column, Retired Money, which will explore smart ways to draw down income in retirement and semi-retirement.
One of the big gifts the Conservatives gave to those at or near retirement is pension income splitting. As with the other forms of income splitting available to family units, pension splitting works best when there is a significant discrepancy in taxable income between the principals involved. In the case of pension splitting, it’s most effective if one member has a large amount of corporate pension income and the other does not.
Referring to the previous article in this column on Topping up to Bracket, you can see how the tax treatment on one $50,000 annual pension would be quite different if that pension were instead split 50/50 between both members of a married couple. With pension splitting, each member would show $25,000 of pension income in their hands, dramatically cutting the income tax due to the couple as a unit.
One nice aspect of pension splitting is that it’s not as complicated as it may sound. You don’t have to actually go to the pension administrator to “split” the benefits paid out. It all happens on your tax forms when you submit your annual taxes.
Note that income splitting for retirees does not have to be limited to traditional Defined Benefit pensions, although DB pensions are perhaps the clearest and most useful example. According to a CIBC paper, up to 50% of annuity-type payments from a pension plan can be split with a spouse at any age (except in Quebec, where the age to split any retirement income for provincial purposes is 65).
“For people over age 65 or receiving payments as a result of the death of a spouse or common-law partner, payments from a Registered Retirement Income Fund (RRIF) may also be split up to 50%,” CIBC says. And, referring back to my first Retired Money article (on the federal pension and age credits), “the first $2,000 from any of these income streams after 65 will also be eligible for the pension credit.”
According to a CIBC paper (Ten RRSP Hacks: January 2016) by CIBC Managing Director, Tax & Estate Planning Jamie Golombek, any pension income qualifying for the $2,000 federal pension income credit also qualifies to be split: including annuity type payments from a Registered Pension Plan (regardless of age), and also including RRIF withdrawals upon reaching age 65. Note, however, that it does not include RRSP withdrawals.
Thus, someone who is 65 and married or living common-law may wish to consider converting part of an RRSP into a RRIF in order to benefit from pension splitting. Apart from the taxes saved by the household as a unit, Golombek notes that pension splitting “also has the ability to affect credits and benefits that are solely based on one spouse’s net income.”
He cites as an example the federal age amount that’s worth about $1,000 but is phased out between income of $36,000 and $83,000. Similarly, Old Age Security benefits worth about $7,000 in 2016 are clawed back with net income between $73,000 and $119,000. “If pension splitting allows you to lower your net income, you may be able to preserve some (or all) of the benefits,” Golombek concludes.
As Robert Armstrong, head of managed solutions for BMO observes, for those lacking a private pension plan, “it is possible to create an eligible pension income by converting a registered plan to its maturity option at 65.” For some, there may be an advantage in NOT deferring the conversion of RRSPs to RRIFs at 71. Armstrong adds that one of the perks of receiving RRIF income earlier at or after 65 is that in addition to qualifying for the pension income tax credit, it is also eligible for the joint election to split pension income with a lower-income spouse/common-law partner. The result can be a much reduced overall household tax bill.”
Before pension splitting, spousal RRSPs were often recommended as a way to split retirement income in a tax-efficient way, again in cases where incomes are in different tax brackets. As Golombek notes, this works if the contributor spouse is always in a higher tax bracket than the annuitant spouse, both before and during retirement.
If the spouse designated as the annuitant has income taxed in their hands instead of the contributor in the higher tax bracket and at a time when the annuitant is in a lower tax bracket than the contributor the year the income is withdrawn, “there may be an absolute and permanent tax savings,” Golombek says.
Thus, pension splitting has not meant the demise of spousal RRSPs. Note too that spousal RRSPs let an individual split more than 50% of pension income. In theory, a spousal RRSP could let you “split” as much as 100% of RRSP or RRIF income with a lower-income spouse, Golombek says. Furthermore, he suggests anyone wishing to split income before 65 and who lacks a Registered Pension Plan, should still consider using a spousal RRSP. In that case, the ultimate withdrawals could being taxed in a lower-income spouse’s hands without having to wait until 65.