The article “How Pension Income Splitting Really Works” was originally published on MoneySense on February 26, 2015.
Ken is trying to get some answers so he can plan a tax efficient retirement income for he and his wife
Q: As I understand it, RRSPs have tax withheld at 30% and then you are taxed based on your income for that year, which could mean a return or more taxes assessed depending on your annual income. If you decide to do pension income splitting with your spouse, does your RRSP need to be converted to a RRIF before income splitting? Are there any other tax implications involved with income splitting? When income splitting, can you withdraw from one spouse’s RRIF and then split the income between husband and wife and continue every year after to help reduce taxes?—Ken
A: I’m always amazed at how much more information exists about contributing to RRSPs versus withdrawing from them. It’s no wonder, given that the vast majority of financial information floating around out there comes from the financial industry. They make money when you invest, not when you divest. But after all the hard work you put into amassing your retirement savings, you owe it to yourself to try to figure out the best way to draw down on your assets.
You’ve got the basic idea on RRSP tax withholding, Ken. That is, withdrawals are taxable and your financial institution has to withhold tax at source. The rate in all provinces other than Quebec is 10% on withdrawals up to $5,000, 20% on withdrawals between $5,000 and $15,000 and 30% on withdrawals in excess of $15,000. But no matter what, withdrawals are taxed on your tax return for the year and your other sources of income determine your tax bracket and your ultimate tax payable.
If you withdraw the minimum required withdrawal amount from your RRIF—an RRSP that has been converted to a Registered Retirement Income Fund—there is no tax withholding. But likewise, tax is payable when you file your tax return.
I like to clarify that income splitting is an election that you make on your annual tax filing. There’s nothing proactive about it and it doesn’t matter whose account the withdrawals go into. It’s an annual tax election that can differ from year to year and you can split anywhere between 0% and 50% of your eligible pension income to minimize taxes by moving the income over to your spouse’s tax return. Ideally, you should use pension income splitting to try to minimize your overall annual tax as a couple each year.
RRSP withdrawals after the age of 65 don’t qualify for income splitting, so to answer your question, Ken, you do need to convert your RRSP to a RRIF.
There are lots of tax implications involved with income splitting, though it depends on your personal situation. Your income for the year determines your eligibility for certain tax credits you can claim on your tax return to reduce tax payable, so if your income is too high, you may not qualify. Likewise for certain tax credits and pensions that are paid out over the course of the year based on your income on your tax return, like the GST/HST credit and Old Age Security pension.
And yes, Ken, you can withdraw from one spouse’s RRSP or RRIF or the other’s and split the income between husband and wife. The caveat is that the pensioner or the one making the withdrawal must be 65 or over during the tax year in question.
There are many implications from RRSP withdrawals. You can balance tax payable as a couple each year retroactively with pension income splitting on your tax filing. But I’d be inclined to look at your retirement funding proactively to try to ensure you are drawing the right amounts from the right accounts at the right time.
Ideally, this planning should start well in advance of retirement, especially if you have different accounts that you could be drawing from. Even if all you have is your RRSP, at least a bit of forethought and planning can help you understand how much you can afford to spend in retirement and how income taxes will impact your retirement savings.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.