What is pension splitting?
Pension splitting is a tax-reduction strategy in which a spouse with pension income (referred to as the transferring spouse) elects to allocate, for income tax purposes, a certain portion of their pension income to their lower-income spouse (the receiving spouse). You can split a maximum of 50% of your pension income.
What are the benefits?
Pension splitting will decrease the transferring spouse’s net income and increase the receiving spouse’s net income (for income tax matters, “spouse” includes a common law spouse). The goal is to reduce your net income enough that you move the pension income to a lower income tax bracket, reducing overall family taxes and possibly increasing credits and benefits, including the age amount, the pension income amount and the spouse amount, and reducing the Old Age Security (OAS) clawback.
The strategy works best when one spouse has significant taxable income and the other spouse has little taxable income. In that situation, pension splitting can save thousands of dollars each year.
How to split your pension
To split your pension, both you and your spouse must file a joint election on your income tax return using form T1032. You may allocate up to half of your eligible pension income to your spouse, but you may also allocate less than half. You and your spouse are permitted to make this joint election only once per taxation year, so if you both have eligible pensions, you must decide which of you will split your pension if you choose to use this strategy. You must make the election each year that you would like to split your pension income.
To qualify, both the transferring and receiving spouses must reside in Canada at the end of the year in question, and you must be in the spousal relationship at the end of the year and for at least nine months in the year. If one spouse passed away during the year, these conditions apply at the date of death rather than at the end of the year.
Eligible pension income
According to the Canada Revenue Agency, the following amounts qualify for pension splitting:
- The taxable part of life annuity payments from a superannuation or pension fund (i.e., an employer pension, including Individual Pension Plans)
- Annuity and Registered Retirement Income Funds/Life Income Fund payments
- RRSP annuity payments
- Certain amounts from retirement compensation arrangements
The last three items listed above require that the transferring spouse be at least age 65; the age of the receiving spouse is not a factor.
If you don’t have eligible pension income, converting a portion of your RRSP to a RRIF when you turn 65 opens up some pension income to split and makes the pension tax amount available, which is up to $2,000 per person (2017).
Certain types of income are not eligible:
- OAS payments
- Canada Pension Plan income
- Most pension income from foreign sources, including US individual retirement accounts
If you have not taken advantage of pension income splitting in the past, note that the CRA allows you to go back three tax years and adjust your tax returns to incorporate the strategy.
Work with your accountant to make sure you don’t miss anything in calculating various pension splitting scenarios for you and your spouse (that is, using different proportions of your pension) to arrive at the most beneficial overall results, taking into account income tax, credits and the OAS clawback. For some types of pension income, conditions apply, so be sure to go over that with your accountant too.