Generous to a Fault: The New Pension Income Splitting Rules
March 2008
This article comes to us from Paul Neilson, a tax partner at Hudson LLP, the Calgary office of our Nexia International affiliation. As an independant member firm of Nexia International, we are able to provide clients with seamless international coverage on financial matters. With 620 offices in over 97 countries, Nexia International ensures that, regardless of where in the world a client’s business ventures take them, their accounting and other financial interests will be protected and served by experts.
In October 2006, the Federal Government announced a plan allowing spouses to split pension income, effectively lowering their overall family tax burden. The plan was entitled the "Tax Fairness Plan" and, ironically, included a new tax on income trusts. The pension splitting aspect of the plan came into effect on January 1, 2007. As a result, seniors receiving eligible pension income will enjoy tax reductions when they file their 2007 income tax returns.
To say the plan is generous is an understatement. The top marginal tax rate for a resident of Alberta is 39%. The lowest rate (which applies to the first $37,178 of taxable income) is 25%. Therefore, if a high income taxpayer allocates $20,000 of pension income to a low income spouse, their overall tax would be reduced by around $2,800 per year.
The tax savings becomes even more significant when the high income spouse receives both old age security ("OAS") and private pension plan income. Because OAS is means tested, and must be repaid when income exceeds a threshold of $63,511, the effective tax rate on income over the threshold is about 45%. Shifting eligible pension income to a low income spouse can reduce the tax rate on the reallocated income to around 25% and eliminate the OAS claw back. The result is a significant savings to the family.
The detailed pension splitting rules allow up to 50% of eligible pension income to be allocated to the non-recipient spouse, provided an election to split income is filed with both spouses' tax returns. Pension income eligible for splitting generally includes monthly private pension plan income, payments under a registered retirement income fund and annuities under an RRSP. Canada Pension Plan benefits and OAS are not eligible for income splitting. As an additional benefit, to the extent the low income spouse is 65 years of age or older, the reallocated income will qualify for the pension income deduction in the hands of the low income spouse.
Along with splitting pension income, any income tax withheld on the reallocated income must be assigned to the low income spouse. This will ensure that pension splitting does not result in one spouse waiting on a large tax refund while the other spouse has a significant amount payable.
About the only possible criticism of the new pension splitting rules is that calculating the amount of income to be split will likely require tax software to optimize the impact of non-refundable tax credits. However this is a small price to pay for annual savings of $3,000 to $4,500 in tax.
About the Author:
As senior tax partner, Paul has successfully piloted the tax group through years of rapidly changing and increasingly complex tax legislation. His areas of expertise include corporate tax planning and reorganizations, estate planning and resource taxation. Paul has also consulted as a policy advisor to the Federal Department of Energy and is co-author of the CCH publication "Canadian Taxation of Oil and Gas Income."
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