Take advantage of tax brackets by splitting your retirement income with your spouse.
You’ve built your retirement nest egg—now how do you get the most out of it? Income splitting can help retired couples keep more after-tax dollars in their pocket.
What is income splitting?
Income splitting is a way of moving income from the higher-income spouse to the lower-income spouse. Because Canada’s tax system is based on progressive tax rates, spouses with more equal income generally pay lower overall taxes. For example, less tax is paid on two incomes of $60,000 than one income of $120,000.
The Canada Revenue Agency provides a few valuable ways to split income between spouses:
- TFSA Contributions
- CPP Pension Sharing
- Pension Income Splitting
- Spousal RRSPs
Tax Free Savings Account (TFSA)
Generally, if you gift money to your spouse for investment purposes, the income and growth attributes back to you. This is not the case with TFSAs: the higher income earner can gift money to a spouse to invest in a TFSA without being taxed for future income and growth.
Canadian Pension Plan (CPP) Pension Sharing
You can apply to have half of your CPP benefits paid to your spouse, provided both of you are over age 60. Half of your spouse’s CPP is then assigned automatically back to you. This evens out the CPP benefits and does not trigger any attribution.
Pension Income Splitting
Up to 50% of your eligible pension income can be allocated to a lower income spouse so it is taxed at a lower rate. Both spouses must agree to Pension Income Splitting by filling out the appropriate areas on their respective tax returns.
Eligible pension income includes:
- Income from a registered pension plan (RPP), regardless of the recipient’s age. (e.g. a pension from an employer-sponsored defined benefit plan or defined contribution plan.)
- Income from a registered annuity, a Registered Retirement Income Fund (RRIF), a Locked-In RRIF (LIF), or a deferred profit sharing plan (DPSP) annuity, if the recipient is 65 years of age or older.
Ineligible pension income includes:
- Old Age Security (OAS)
- Guaranteed Income Supplement (GIS)
- Canada Pension Plan/Quebec Pension Plan
- Registered annuities, RRIFs, LIFs, and DPSP annuities if recipient is under age 65
- RRSP withdrawals
- Income from Retirement Compensation Arrangements (RCAs)
Spousal RRSPs allow the higher-earning spouse to invest for the benefit of the lower income spouse and claim the tax deduction. With the introduction of Pension Income Splitting in 2007, there is a reduced need for Spousal RRSPs, but there are some circumstances when a spousal RRSP contribution still makes sense:
- Since RRIF income cannot be split until age 65, contributing to a spousal RRSP provides an opportunity for a more even allocation of retirement income before age 65.
- For those with available RRSP contribution room after age 71 and a spouse that is younger than age 72, a spousal RRSP contribution can provide additional tax savings.
Even if you take advantage of all these income splitting opportunities, the amount of tax savings will vary greatly among couples, depending on each person’s tax bracket. You should also consider the impact that a higher income may have on the lower income spouse’s personal tax credits and Old Age Security benefits. Attributing too much income to the lower spouse could result in the reduction or elimination of these benefits.
In most cases, income splitting is a quick win for couples looking to maximize their after-tax retirement income, but careful planning is required. An ATB Investor Services advisor can help you take full advantage of these opportunities.
Chris Turchansky, CFA
Managing Director, ATB Investment Management