The article “Should You Always Split Your Pension Income?” was originally published on MoneySense on March 15, 2021.
Narayan wants to know the best ways to save income tax, given the disparity between his income and his wife’s.
Q. Is it always advantageous to use pension income splitting? I have a very high pension income, but my wife does not have much.
A. Income splitting is a strategy to move income from a high-income taxpayer to a lower income family member, with an aim to lower the household’s overall tax bill. There are many ways to do this, but perhaps none is easier than pension income splitting in retirement.
Pension income splitting allows eligible pension income to be reallocated from one spouse to another. Practically speaking, it results in a tax deduction on line 21000 of a T1 tax return—a split-pension deduction—or the higher-income spouse. The recipient spouse claims an income inclusion on line 11600 for the split-pension amount. The result is that the income is effectively moved from one spouse to the other.
Married or common-law taxpayers jointly elect to split their pension income when they file their tax returns, so this is a retroactive tax strategy. This allows pension income splitting to be fine-tuned after the initial preparation of both spouses’ tax returns.
Eligible pension income has limits both before and after age 65. Before a pension income recipient reaches age 65, the most common sources of eligible pension income to split with their spouse include defined benefit (DB) pension income and taxable foreign pension income, like U.S. Social Security. (For the full list, see here.)
After age 65, more income sources become eligible, including Registered Retirement Income Fund (RRIF) withdrawals, defined contribution (DC) pension withdrawals and annuity income. Note that Registered Retirement Savings Plan (RRSP) withdrawals are not eligible, so to split RRSP income with a spouse, you need to convert your RRSP to a RRIF. (The full list after age 65 is here.)
Common pensions, like Canada Pension Plan (CPP) and Old Age Security (OAS) are not eligible for pension income-splitting. A CPP retirement pension is eligible for pension sharing (you need to send an application to Service Canada, and you can only split the portion earned during your relationship). You can apply before or after you start to receive benefits to have your pension and your spouse’s pension split equally. This may result in more CPP benefits being payable to the spouse who did not contribute as much to CPP. (See here for more information.)
Unfortunately, for those with U.S. retirement savings, Individual Retirement Accounts (IRAs) are not eligible for pension income splitting regardless of the age of the account holder.
To answer your question about whether it always makes sense to split your pension income, Narayan: It depends.
If your wife has a lower income, it will probably make sense to split some of your eligible pension income with her, up to the 50% allowable transfer. There could be situations when, depending on your respective tax deductions and credits, you may not want to transfer pension income or may not want to transfer the maximum. Tax software, whether professional or retail software, can be used to determine the optimal transfer amount that results in the least combined income tax payable on your incomes.
One example of a situation when splitting pension income with a lower income spouse could trigger more tax payable is if that lower income spouse is receiving OAS and they are subject to a clawback of their pension, but the higher income spouse is not receiving or subject to OAS clawback. The pension recipient’s income could be higher, but the effective tax rate of their lower-income spouse could be higher due to the OAS clawback. In this instance, splitting pension income may increase your combined tax.
Many taxpayers have more ability to control the timing and degree of their tax payable in retirement due to their different sources of potential income. You can only spend your after-tax income, so the tax you pay will have a big impact on your retirement lifestyle and, ultimately, the size of your estate for your beneficiaries.
Pension income splitting is just one tool that is available to retirees to minimize their tax payable.
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.