Pension Splitting 

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Pension Splitting

Low to middle income seniors can benefit from new rules.

FROM: NOV-DEC 2007 ISSUE | BY MANU KAKKAR

With the 2007 personal tax season around the corner, I thought it would be prudent to review the new pension splitting rules that will be in effect for the 2007 taxation year. The tax policy behind these new pension splitting rules is to reduce the tax burden on low to middle income seniors who receive eligible pension income.

Canadian resident pensioners who receive eligible pension income that qualifies for the existing pension income tax credit will be permitted to transfer up to one-half of that pension income to their spouse or common-law partner (“transferee”). The amount so transferred is a deduction in arriving at a taxpayer’s net income and not taxable income. A joint election needs to be made by both taxpayers in a prescribed form filed with each of their tax returns. If it is not filed in time, the ability to pension split between the spouses will be lost for that taxation year.

The maximum amount of pension that can be split is pro-rated based on the number of months that a taxpayer has been married or in a common-law partnership in the taxation year. This means the pensioner can only achieve a partial split of eligible pension income in the first year of matrimony or common-law partnership and a complete split every year thereafter.

The major implications of these rules are:

1. They will provide income splitting opportunities to spouses or common-law partners who are in different tax brackets. The tax burden will be reduced by fully using the couple’s combined graduated tax rates.
2. Both spouses will be able to benefit from the pension credit.
3. Splitting the pension may help the pensioner avoid Old Age Security clawback, which is based on a taxpayer’s net income reaching a certain threshold, by reducing the taxpayer’s net income.
4. The age credit will be increased because the pension income transferred may reduce net income to avoid a clawback.

It is clear that these rules only benefit low to middle income taxpayers. If both spouses are in the highest tax bracket, there will be no positive tax result generated.

I have been asked what type of pension income qualifies. That depends on how old the pensioner is. If the pensioner is 65 years or older in the year he receives the pension then the major types of qualifying pension income that can be allocated to the transferee are:

• Life annuities from a superannuation or pension plan;
• Income from an RRSP annuity; and
• Payments from an RRIF.

If the pensioner is under 65 years of age then the major types of qualifying pension income that can be allocated to the transferee are life annuities from a superannuation or pension plan.

However, there are similarities in the pension splitting rules regardless of age. First, CPP and OAS payments are not eligible for the pension splitting rules. It should be noted that current tax legislation permits CPP splitting among spouses if certain conditions apply. Second, where the pensioner receives foreign pension income that is exempt from Canadian taxation by virtue of a tax treaty, such amount is not eligible for pension splitting. It therefore follows that pension income that is taxable in Canada is eligible for the pension splitting rules.

These pension splitting rules will provide a valuable tax planning tool to many seniors in Canada on one of their largest sources of income. Starting with the 2007 personal tax season, CGAs will need to familiarize themselves with both the compliance and conceptual issues surrounding these rules.

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