Any taxpayer told of a strategy that offered the possibility of saving hundreds or thousands of dollars in tax and increasing his or her eligibility for government benefits while requiring no advance planning, no expenditure of funds, and almost no expenditure of time could be forgiven for thinking that what was proposed was an illegal tax scam. In fact, that description applies to pension income splitting which is a government-sanctioned strategy to allow married taxpayers over the age of 65 (or, in some cases, age 60) to minimize their combined tax bill by dividing their private pension income in a way which creates the best possible tax result.
Many Canadians, even those in a position to benefit from pension income splitting, have never heard of it. That’s because the strategy gets very little coverage in the media. While Canadians are inundated during the first two months of the year with advertisements extolling the virtues of making contributions to registered retirement savings plans (RRSPs) or tax-free savings accounts (TFSAs), pension income splitting is never mentioned. The reason for that is that it is one of the very few tax planning strategies in which no one but the taxpayer gains a financial benefit.
The information provided with the annual tax return form also doesn’t highlight the benefits of pension income splitting, and the form needed to carry out a pension income splitting strategy isn’t included in the General Income Tax Return package. The Guide issued by the Canada Revenue Agency (CRA) for 2015 returns does flag the pension income splitting option, in the same manner as all other deductions and credits which may be of particular relevance to seniors. However, the material on income splitting included in the Guide addresses only the mechanics of filing — which number goes where — with no significant explanation of the tax-saving benefits which can be obtained. Consequently, unless a taxpayer is getting good tax planning or tax return preparation advice, it’s likely that he or she could overlook a significant opportunity to reduce his or her tax burden.
Dividing income between spouses makes for a lower overall tax bill because of the way our tax system is structured. Canada’s tax system is what is known as a “progressive” tax system, in which the rate of tax imposed increases as income rises. In very general terms, for 2015, the first $45,000 of taxable income attracts a combined federal-provincial rate of around 25%. The next $45,000 of such income, however, is taxed at a rate of just under 35%. When taxable income exceeds about $140,000, the tax rate imposed can approach 50%. While those percentages and income thresholds will vary by province, provincial and territorial tax rates will, in every province or territory, increase as taxable income goes up. Dividing income allows a greater proportion of that income to be taxed at lower rates. Of course, that means that the total tax payable (and therefore government tax revenues) will be reduced. Consequently, our tax laws include a set of rules known as the “attribution rules” which seek to prevent strategies to divide income in this way. Pension income splitting is a government-sanctioned exception to those attribution rules.
The general rule with respect to pension income splitting is that taxpayers who receive private pension income during the year are entitled to allocate up to half that income with a spouse for tax purposes. In this context, private pension income means a pension received from a former employer and, where the income recipient is over the age of 65, also includes payments from an annuity, an RRSP, or a registered retirement income fund (RRIF). Government source pensions, like payments from the Canada Pension Plan, Quebec Pension Plan or Old Age Security payments do not qualify for pension income splitting, regardless of the age of the recipient.
The mechanics of pension income splitting are relatively simple. There is no need to transfer funds between spouses or to make any change in the actual payment or receipt of qualifying pension amounts, and no need to notify a pension plan administrator.
Taxpayers who wish to split eligible pension income received by either of them must each file Form T1032-15e, Joint Election to Split Pension Income, with their annual tax return. That form, which is not included in the annual tax return package, can be found on the CRA website at www.cra-arc.gc.ca/E/pbg/tf/t1032/README.html, or can be ordered by calling 1-800-959 8281.
On the T1032-15e, the taxpayer receiving the private pension income and the spouse with whom that income is to be split must make a joint election to be filed with their respective tax returns for the particular tax year. Since the splitting of pension income affects the income and therefore the tax liability of both spouses, the election must be made and the form filed by both spouses — an election filed by only one spouse or the other won’t suffice. In addition to filing the T1032-15e, the spouse who actually receives the pension income must deduct from income the pension income amount allocated to his or her spouse. That deduction is taken on line 210 of his or her return for the year. And, conversely, the spouse to whom the pension income is being allocated is required to add that amount to his or her income on the return, this time on line 116. Essentially, to benefit from pension income splitting, all that’s needed is to for each spouse to file a single form with the CRA and to make a single entry on his or her tax return for the year.
Generally, when taxpayers sit down to complete their income tax returns this spring, it will be too late to take any action which will reduce taxes payable for the 2015 tax year — in most cases, such actions needed to be taken before the end of the 2015 calendar year. One of the best attributes of pension income splitting as a tax planning strategy is that it doesn’t have be addressed until it’s time to file the return for 2015. By the end of February or early March, taxpayers will have received the information slips which summarize their income for the year from various sources. At that time, couples who might benefit from this strategy can review those information slips and calculate the extent to which they can make a dent in their overall tax bill for the year through a little judicious income splitting.
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