Understanding Pension/ Retirement Income Splitting in Canada
Do you want to lower your tax burden? Well, we don’t suggest evasion of taxes. Instead, we strategically plan to reduce your overall tax outgo. Pension income splitting is an effective way to reduce your taxable income. Let us understand this concept together and lead you towards savings.
Elliot and Sara are both 67 years old. They both retired two years back. Elliot is a freelancing consultant and still earns about $25,000 annually. Besides this, he also receives a pension income of $3,500 monthly, which takes him to an annual income of $67,000.
On the other hand, Sara survives only on her pension income. She gets $2,500 monthly. It translates into an annual income of $30,000 and pays tax at a comparatively lower tax bracket.
Since the couple is retired and is primarily surviving on pension income, they were looking for ways to reduce their tax liability. They approached their financial advisor and advised them about splitting the pension income.
In Canada, pension income splitting is legal and practiced by several retirees. Read out more to know everything about it.
What Is Pension Income Splitting?
According to the Canadian Pension Splitting Rules, you can split up to 50% of your eligible pension income with your spouse or common-law partner.
The pension income so split will not be a part of your taxable income, and you will not be required to pay income tax on it. Instead, such a pension will get included in your taxable income. You will have to pay the tax as per the prevailing slab rates.
Additionally,
- To enjoy the benefits of pension income splitting, you must be at least 65 years of age at the end of the year.
- Fill out “Joint Election to Split Pension Income” while filing your income tax return. You can access this form via this link.
- You can only split your eligible pension income (explained below) with your spouse or common-law partner.
- It gives rise to ineligible pension income (also explained below) that you cannot split. 100% of such pension income will get added to your taxable income, and you will be required to pay taxes.
What are Eligible and Ineligible Pension Income?
To completely understand the concept of pension income splitting, you must become aware of all amounts you can split. Refer to the table below, and you will find all your answers:
| Eligible Pension Income | Ineligible Pension Income |
| The taxable annuity payments received from: Superannuation Pension funds Retirement plans | All the payments that are associated with old age security (OSA) |
| Annuity payments and incomes from R. R. S. P (Registered Retirement Savings Plan) | All the payments received under Canada Pension Plan and Quebec Pension Plan |
| Amounts distributed from Retirement Compensation Arrangement are qualified | Any pension income that is received from abroad and is tax-free in Canada |
| Income from D. P. S. P (Deferred Profit-Sharing Plan) | Income received from I. R. A (Individual retirement Account) run by the United States |
| Regular annuities received from I. A. A. C (Income Averaging Annuity Contracts) | Line 11500 amounts received from R. R. I. F (Registered Retirement Income Fund) and transferred to: Another R. R. S. P (Registered Retirement Savings Plan) Another R. R. I. F (Registered Retirement Income Fund) Another annuity plan |
| Retirement benefits and all the retroactive lumpsum payments received from R. P. P (Registered Pension Plans) | |
| Income received from R. R. I. F (Registered Retirement Income Fund) | |
| Benefits received from E. B. P (Employee Benefit Plans) | |
| Any pension received from foreign, such as US Social Security |
How Does Pension Income Splitting Work?
Let us make you understand the process through a practical example.
Michael Brown is a federal retiree and is 68 years old. He presently works as a part-time consultant with an organization. He is contemplating splitting his pension income with his spouse to reduce his overall tax burden.
He received the following taxable income this year:
| Particulars | Amount |
| Income from D. P. S. P (Deferred Profit-Sharing Plan) | $40,000 |
| Pension from US Social Security | $20,000 |
| Income from Consultancy | $50,000 |
| Payments from Canada Pension Plan | $15,000 |
| Annuity received from Income Averaging Annuity Contracts | $15,000 |
| TOTAL | $140,000 |
As per the federal income tax rates of 2022, Michael needs to pay income tax calculated in the following manner:
| Particulars | Tax Rate | Calculation | Tax Liability |
| On the first $50,197 | 15% | $50,197 x 15% | $7,529.55 |
| On the next $50,195 | 20.5% | $50,195 x 20.5% | $10,289.975 |
| On the balance income of $39,608 $140,000−$100,392 | 26% | $39,608 x 26% | $10,298.08 |
| TOTAL | $28,117.605 |
Let us divide the income received by Michael into Eligible and Ineligible Pension Income.
| Particulars | Eligible Pension Income | Ineligible Pension Income |
| Income from D. P. S. P (Deferred Profit-Sharing Plan) | $40,000 | |
| Pension from US Social Security | $20,000 | |
| Income from Consultancy | $50,000 | |
| Payments from Canada Pension Plan | $15,000 | |
| Annuity received from Income Averaging Annuity Contracts | $15,000 | |
| TOTAL | $75,000 | $65,000 |
Michael split 50% of his eligible pension income with his spouse. His total taxable income will be:
| Particulars | Amount |
| Eligible Pension Income (after splitting) ($75,000 x 50%)($𝟕𝟓,𝟎𝟎𝟎 𝒙 𝟓𝟎%) | $37,500 |
| Ineligible Pension Income | $65,000 |
| Total Income | $102,500 |
The total tax liability for Michael after pension income splitting will be:
| Particulars | Tax Rate | Calculation | Tax Liability |
| On the first $50,197 | 15% | $50,197 x 15%$50,197 � 15% | $7,529.55 |
| On the next $50,195 | 20.5% | $50,195 x 20.5%$50,195 � 20.5% | $10,289.975 |
| On the balance income of $2,108 $102,500−$100,392$102,500−$𝟏𝟎𝟎,𝟑𝟗𝟐 | 26% | $2,108 x 26%$2,108 � 26% | $548.08 |
| TOTAL | $18,367.605 |
Conclusion
- Using the technique of pension income splitting, Michael was able to reduce his tax liability from $28,117.605 to $18,367.605. This translates into a savings of:
- $9,750 ($28,117.605−$18,367.605)$9,750 ($28,117.605−$18,367.605)
- 34.67% ($9,750$28,117.605 x 100)34.67% ($9,750$28,117.605 x 100) or we can say approx. 35%
Wrapping it up
Pension income splitting is a legal way of reducing your taxable income. You can split up to 50% of your eligible pension income with your spouse or common-law partner. The pension income so split is not taxable in your hands and becomes tax-free for you.
Hence, if you fall in a marginal tax bracket higher than your spouse, you should consider using this technique to reduce your overall tax liability.
