Your Finances with Stephen Maltby
In Canada, individuals file his or her own tax return and is taxed on the income he or she earns on an individual basis. In the United States they allow the filing of joint returns in which both spouses can choose to pool their incomes on the same return, with higher joint tax brackets for the couple than for a single person.
We have a progressive tax system in Canada, and the more an individual makes, the higher the tax rate. This is always an issue for senior couples, where one spouse receives a pension while the other has very little income. The couple would be far better off and pay significantly less tax if the pension income, which is being used to support the couple jointly, could be split between both partnersâ€™ tax returns. This is an option under Canadian tax law.
Any Canadian resident who receives income that qualifies for the existing pension income tax credit, can allocate up to one-half of qualifying pension income to his or her resident spouse or common-law partner. The definition mirrors the definition of pension income for purposes of the $2,000 pension income amount. For Canadians who are 65 years and over, eligible pension income includes lifetime annuity payments under an RRSP, RPP (registered pension plan) or a deferred profit-sharing plan, as well as any payments out of a RRIF. For those under age 65, eligible pension income includes lifetime annuity payments under an RPP, and certain other payments received as a result of the death of the individualâ€™s spouse or partner. Old Age Security and Canada Pension Plan payments are not eligible pension income. (CPP/QPP can already be split under separate legislation).
The pension income that one spouse chooses to allocate to his or her spouse may be simply deducted from the income of the spouse or partner who actually receives the income and included on the otherâ€™s tax return. Up to 50% of pension income can be allocated to a spouse or partner. The election to split can be made one year at a time and can be changed or modified each tax year, depending on financial circumstances and planning needs.
OAS clawback planning
Under pension splitting rules, pension income being transferred qualifies for the $2,000 pension income credit in the hands of the transferee spouse. It is also deducted from the transferorâ€™s income and included in the transfereeâ€™s net income for the purposes of determining any clawback of OAS benefits. The OAS clawback, which only affects about 3% of eligible Canadian seniors, kicks in at net income greater than $70,954 in 2013 and is fully clawed back when net income reaches $114,815. The ability to split pension income is extremely beneficial for clients who are subject to OAS clawbacks. Pension income that pushes an individual above $70,954 (for 2013) can be transferred to a lower-income spouse or partnerâ€™s return, thus preserving OAS payments for the higher income spouse.
Spousal/common-law partner RRSPs
So how do these rules affect spousal/common-law partner RRSPs. It is often used by spouses/partners to accomplish post-retirement income splitting so withdrawn funds are taxed in the hands of the annuitant spouse/partner instead of the contributor spouse/partner. If the annuitant spouse/partner is in a lower tax bracket than the contributor spouse/partner in the year of withdrawal, there may be an absolute and permanent tax savings. If an individual is under 65, eligible pension income typically only includes payments from an RPP and will not generally include amounts paid from an RRSP or RRIF. So anyone who wants to retire before age 65 and does not have an RPP should still consider the use of spousal/common-law partner RRSP contributions, which would allow the ultimate withdrawals to be taxed in a lower-income spouseâ€™s or partnerâ€™s hands without having to wait until age 65.
Post-death RRSP Rules
The spousal/common-law partner RRSP still plays a role in a situation where an individual dies with unused RRSP contribution room. In that scenario, assuming the will permits it, the executor or estate representative can make an RRSP contribution to spousal/common-law partner RRSP for the survivor and obtain one final RRSP deduction on the deceasedâ€™s terminal return
Stephen Maltby is an Investment Adviser and Chartered Accountant with CIBC Wood Gundy. He has been in the financial services industry for more then 30 years and has held various accounting, investment and management positions with several accounting and investment firms over the years. He is in addition to his Advisor role a First Vice-President and Executive Director Atlantic Canada, CIBC Wood Gundy.