The government generally disapproves of income splitting between family members. However, a special rule in the Income Tax Act(ITA) allows you to split certain pension income with your spouse or common-law partner.
Under the rule, you and your spouse can make a joint election, whereby you allocate a share of your pension income to your spouse. You can allocate up to 50% of income in this way. The split amount is reported on your spouse’s tax return, and you report the other portion yourself. The election must be made each year, which means you can change the amount split for each tax year, or you can choose not to split in a given tax year.
Splitting is permitted even if you don’t actually transfer a portion of the pension income to your spouse.
Mandatory: specified pension income
Pension income must be “specified pension income”.
In general, if you turn 65 or older during the year, your specified pension income includes pension benefits and annuity payments from a registered pension plan (RPP), a group RPP, a registered retirement savings plan (RRSP) or a registered retirement income fund (RRIF).
If you are under age 65 at the end of the year, specified pension income includes only “eligible pension income”, which refers to annuity payments from an RPP. However, eligible pension income may also include other annuity payments described in the previous paragraph arising from the death of a former spouse (i.e. other than your current spouse with whom you are income splitting).
Specified pension income does not include benefits from government plans such as the Canada Pension Plan, the Quebec Pension Plan and the Old Age Security program.
3 advantages of splitting
1. Pension income splitting is particularly advantageous if you are in a higher marginal tax bracket than your spouse. Splitting will save you tax because the split amount will be subject to a lower tax rate.
2. Another advantage of pension splitting is the possibility of doubling the pension credit. The federal credit is equal to 15% of the first $2,000 of specified pension income, while the provincial credit depends on the province of residence; together, the two credits are worth approximately $450 to $500, depending on the province. You can apply for the credit and, assuming your spouse also qualifies, he or she can apply too. In this respect, the characteristic of pension income in your hands passes to your spouse. For example, if the pension income is eligible pension income, your spouse can claim the credit even if he or she is under age 65. If the pension income is of another type, your spouse can only claim the credit if he or she is age 65 or over.
Another example to help you understand?
You are 68 years old and receive RRSP income during the year that is not eligible pension income. You can choose to allocate up to 50% of the income to your spouse. You can apply for the pension credit. If your spouse is 65 or over, he or she can claim the pension credit. If your spouse is under 65, he or she cannot apply for the credit.
3. Another potential benefit is the Old Age Security (OAS) clawback tax. This tax effectively requires you to repay a portion of your OAS benefits if your income exceeds a monetary threshold ($75,910 in 2018). The recovery tax is 15% of the amount by which your net income exceeds the threshold, up to the amount of your SV income. Therefore, if you would otherwise be subject to clawback tax, you may be able to reduce or even eliminate it by splitting your pension income with your spouse.
In the same case, the age credit is phased out starting at an income of $36,976 (2018 amount). Depending on your income, pension income splitting may allow you to restore your age credit.
But don’t forget: you have a joint responsibility!
Your spouse will be required to pay tax on the split amount included in his or her income. However, you will also be jointly and severally liable for this tax. This means that, if your spouse doesn’t pay the tax, the CRA can claim it back from you.
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