Income splitting requires balance

(November 2007) Canadians receiving pension payments were probably happy with the federal government’s decision to allow income splitting in the 2007 budget, but most will still require guidance, according to one tax and retirement planning specialist.

“They should be aware of what kinds of income are actually eligible for the splitting,” says Dave Ablett, manager, advanced financial planning support, at Investors Group.

Income from an RRIF is eligible for splitting, assuming that the owner of the RRIF is at least 65 years of age, Ablett points out. Pension income, however, may be split regardless of age. Some pensions allow workers to retire well before the age of 65, and so long as the pension payments are recurring, the income may be split, regardless of age.

“If they’re receiving a periodic pension benefit, that income will qualify for income splitting, even if the person has started a second career,” Ablett says.

“The question people need to be asking is ‘does this income qualify for the federal pension income credit?'” says Ablett. “If your income would qualify for that credit, it would qualify for income splitting with your spouse.”

Assuming that a client is over the age of 65 and collecting RRIF income, that income will generate a federal credit on the first $2,000. That income may be split with the spouse, who may then allocate that income as pension income on his or her own taxes, even if still employed.

“If they’re under 65, they won’t qualify for the credit until they reach 65,” Ablett explains. “If both of them are over 65, then in addition to being able to split income between two parties, you’ve now created the pension income credit for each one as well.”

There are caveats, however. Income splitting can affect other credits and benefits.

For example, the spousal credit of $9,600 will be reduced by any amount earned by the spouse. But Ablett says the tax savings by the pension recipient will usually more than make up for any amount lost on the spousal credit.

Pension recipients over 65 whose income is in excess of $63,511 would be subject to a clawback on their OAS payments. Not only will splitting reduce the overall taxes for the family, but it could also save them from any clawback on their OAS.

“What they have to be careful about is that they don’t allocate so much to the other spouse that it puts the other spouse above $63,511,” says Ablett. “They should take a look at both incomes to make sure it makes sense to make the full 50% allocation.”

That $63,000 and change isn’t the only ceiling to keep an eye on. If the lower-income spouse sees their income rise to above $30,936, they will be subject to a reduction to their age credit.

One downside to income splitting is that current rules do not allow the pension administrator to reduce the withholding tax at the source. Pension-earning spouses who are paying tax in installments may want to calculate a reduction in the amount they pay to match their new, post-income-splitting circumstances.

“They should be careful in how much they reduce their installments,” warns Ablett. “If there was a tax liability, there could be a penalty.”

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com