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Over the years, governments have adopted various tax measures to allow retired taxpayers to split income with their spouses or common-law partners. This article looks at some of those measures.
By: SLGI Tax & Estate Planning Team
Over the years, governments have adopted various tax measures to allow retired taxpayers to split income with their spouses or common-law partners (CLP). Theses measures exist to help couples lower their tax bill when an economic disparity exists. It allows the higher income earning spouse/CLP to shift some of their income into the hands of their spouse/CLP, thereby benefiting as a family from our graduated tax system.
This article looks at some of the measures that allow couples to split their income in retirement.
A spouse/CLP can share up to 50% of their eligible pension income with their spouse. To split pension income, a joint election is filed with each spouse’s income tax return. What’s important to note is that income is split for tax purposes, only. No money changes hands.
The following qualify as eligible pension income for individuals in the year they turn 65 or later:
For those who are under 65 for the entire tax year, qualified pension income is more limited, and includes:
The pension income amount is a federal, non-refundable tax-credit of up to $2,000 which a person can claim if they have eligible pension income. The maximum federal tax savings available is $300 ($2,000 × 15%). As well, the provinces and territories have their own pension income credits, which can increase the tax savings. If one spouse has eligible pension income and the other does not, pension income splitting allows each spouse to claim this credit, resulting in family tax savings.
See section above for what qualifies as eligible pension income for the purpose of the pension income amount.
Note: Income from Old Age Security (OAS) and the Canada or Quebec Pension Plan (CPP/QPP) does not qualify for pension income splitting or the pension income amount.
Another tool available to families to reduce their household tax bill is CPP/QPP pension sharing. Like pension income splitting (discussed above), the goal is to reduce the family's overall tax rate by shifting income from the higher income spouse to the lower income spouse. Unlike pension income splitting, money actually does change hands.
To qualify for CPP/QPP retirement pension income sharing, both spouses/CLPs must be:
CPP/QPP pension sharing does not change the total CPP/QPP that a couple can receive. It usually changes the amount that each person receives, so can often result in tax savings as a family.
The part of CPP/QPP that can be shared is based on the number of months you have lived together during the “joint contributory period.” The joint contributory period starts when the older spouse/or CLP turns 18 and ends when both starts to receive CPP/QPP pensions.
John and Jill are CLPs and both receive their CPP retirement pensions. John is one year older than Jill and they both decide to take their CPP starting at age 65. Without CPP pension sharing, John’s CPP retirement pension is $1,000 per month while Jill’s is $500 per month. Since the joint contributory period began when John turned 18 and ended when Jill turned 65, their joint contributory period is 48 years. The amount of CPP that can be shared depends on how many years John and Jill have lived together as a part of their joint contributory period. For example, if John and Jill have lived together for 36 years (75% of their joint contributory period) then $400 of their retirement pension can be shared ($500, representing the difference between John’s and Jill’s CPP/QPP retirement pensions x 75% = $375). Half of that amount, $187.50, can be subtracted from John’s retirement pension and added to Jill’s retirement pension.
Pension sharing can stop at any time by a submitting a cancellation request, which must be signed by both spouses or CLPs. It will also stop upon death, separation or divorce.
Sam and Sally reside in Ontario and have lived together long enough to allow for maximum CPP pension sharing. Sam's RPP income is eligible pension income for the purposes of pension income splitting. The table below shows the tax savings they gain from splitting their pension and sharing their CPP income. Please note that for this example, tax rates and credits used are Federal and Ontario rates for 2023.
A spousal RRSP is an RRSP that is opened by one spouse/CLP (first spouse/CLP), as the annuitant, but is directly contributed to by the other spouse/CLP (second spouse/CLP). It is separate from the RRSP that the first spouse/CLP partner opens, as the annuitant, and contributes to themselves.
The amount that a spouse/CLP can contribute to a spousal RRSP is based on the contributing spouse’s RRSP contribution limits. And, it is the contributing spouse/CLP who claims the tax deduction. The spouse/CLP that is the annuitant makes all investing decisions regarding the spousal RRSP.
Despite the introduction of pension income splitting and CPP/QPP sharing, for example, a spousal RRSP continues to be useful strategy to incorporate into a retirement plan. Contrary to eligible pension income (see section above), it provides an opportunity to split income at any age. Also, it allows you to choose the amount of income you can potentially split with your spouse/CLP. It lets you decide how much to contribute and therefore how much you can split, without limiting you to a percentage of 50% of eligible pension income (see section above), for example.
However, you need to be mindful of the spousal RRSP attribution rules. If a spousal contribution has been made in the current year or the two previous years, any withdrawals made from the spousal RRSP will be taxed to the spouse who contributed to the spousal RRSP.
Since 2018, incorporated business owners have had to grapple with the new Tax on Split Income (TOSI) rules. These rules specify that dividends -as well as other amounts- paid by private corporations to an individual from a related business may be taxed at the top marginal tax rate. A related business is a business in which a family member is actively involved in or has a significant capital interest.
There are however a few exclusions from TOSI (i.e., excluded amounts). When the criteria for these exclusions are met, payments can made to an adult family member, taxed at their -hopefully- lower marginal tax rate, and not subject to TOSI. One of these exclusions allows a business owner, who has reached age 65 during the year, to pay a dividend to their spouse/CLP, who owns shares of the corporation.
This exception is available when the following conditions are met:
Note that there is no requirement for the business owner to retire.
Finally, the TOSI rules and their applicability are complex. Consulting with qualified tax specialist is recommended before making any decisions.
No one wants to pay more taxes than required. This is especially true in retirement when income may be limited and inflation could be a threat. In this environment, being aware of the various income splitting opportunities allows investors to potentially further stretch their retirement income.
Important information
Information contained in this article is provided for information purposes only. Its not intended to provide or be a substitute for professional, financial, tax, insurance, investment, legal or accounting advice and should not be relied upon in that regard. It also does not constitute a specific offer to buy and/or sell securities. You should always consult your financial advisor or tax specialist before undertaking any of the strategies discussed in this article to ensure that all elements and your personal circumstances are taken into consideration in developing your individual financial plan. Information contained in this article has been compiled from sources believed to be reliable, but no representation or warranty, express or implied, is made with respect to its timeliness or accuracy and SLGI Asset Management Inc. disclaims any responsibility for any loss that may arise as a result of the use of the strategies discussed.
The examples presented are hypothetical in nature and are provided for illustrative purposes only. Examples include certain material factors or apply certain assumptions to draw conclusions believed to be appropriate in the circumstances, but are not intended to represent an advisors or investors personal scenario. Prior to making any decisions or taking any action, an advisor should conduct a thorough examination of their circumstances prior to implementing any of the strategies discussed herein as there could be additional complexities outside the scope of materials discussed in this article.
