How cost and income splitting benefits couples in retirement
For most of our lives, tax reduction rests on smart savings. We invest money into RRSPs and TFSAs to bypass the tax man so we can fund our future retirement. But during retirement, those options are no longer available to us.
Instead of putting money away and escaping taxes, we’re pulling money and increasing our tax burden with every withdrawal. To make things worse, this is all happening when we’re on a fixed budget.
That’s why you need a separate tax plan to reduce your tax burden after your working years.
And one of the most effective ways to lower your tax burden is to split your income with your spouse.
How income splitting works
Whether by design or not, the tax code heavily favours married couples. Income splitting is one way to take advantage of that.
The method is straightforward. If a couple wants to earn $100,000/year in retirement, they pull that amount from their savings, then each person claims $50,000 on their taxes. This spreads the tax burden across two people, allowing each to duck under the higher tax brackets that come past $50,000/year.
A single person, on the other hand, would have to pull the full $100,000 from their own account. So, almost half of their income is taxed at a higher rate.
Let’s take a closer look:
Goal
Married couple Rachel and John and bachelor Thomas want to earn $100,000/year pre-tax income. Each has maxed out their CPP and OAS.
Thomas
Income
CPP – $17,196
+
OAS - $7,049.55 (minus $1,350.45 clawback for exceeding the limit)
+
RRIF withdrawal – $75,754.45
=
$100,000/year
Taxes owed
Federal – $11,908
Provincial – $8,568
Take home
$79,524
Rachel and John
Income
CPP – $17,196 (times two = $34,392)
+
OAS – $8,400 (times two = $17,464.08)
+
RRIF withdrawal – $48,143.92 (together, or $24,071.96 each)
=
$100,000/year
Taxes owed
Federal – $6,791
Provincial – $5,332
Take home
$87,877
Rachel and John are not only taking home $8,353 more as a couple, but they’re also withdrawing $27,610.53 less than Thomas needs to. That’s a significant difference.
An apples-to-apples comparison
Of course, as a single person, Thomas spends less money every year, so he probably won’t need as much to live on during retirement. However, even here, couples have it easier. According to RBC, single people pay 1.18x more compared to those with a partner.
That’s because couples often save more by splitting the cost of:
- Rent
- Groceries
- Living (utilities, subscriptions, phone plans)
So, let’s look at that calculation again through this lens.
Take two
Thomas, to achieve a similar lifestyle to Rachel and Thomas (at $50,000/year each), would need roughly $59,000/year
So, both Thomas and the couple would duck under the OAS clawback limit, but Thomas would just step into a higher federal tax bracket, paying an extra 5.5% tax on $1,256 of his income (or $333.12). To make up for that, Thomas would need to draw more money and pay more taxes.
Let’s chart this out (excluding OAS and CPP for simplicity’s sake).
Rachel and John’s goal (per person)
$50,000/year after-tax income
Required income & taxes
- Income: $62,848
- Federal Tax: $7,455
- Provincial Tax: $5,392
- Total tax: $12,848
- Average tax rate: 20.44%
- Marginal tax rate: 33.25%
Thomas’ goal
$59,000/year after-tax income (1.18x higher than someone in a couple)
Required income & taxes
- Income: $76,331
- Federal Tax: $10,219
- Provincial Tax: $7,111
- Total tax: $17,331
- Average tax rate: 22.70%
- Marginal tax rate: 33.25%
When comparing per person (i.e., a single person vs. a single person in a relationship), Rachel and John each need $13,483 less than Thomas does, and they each pay $4,483 less in taxes.
So, Rachel and John can seriously benefit simply by splitting their income and costs.
What income can you split in retirement?
Not all retirement income can be split. Old Age Security and foreign retirement income, for example, are both stuck to the person with their name on the account.
Arguably, however, more types of retirement incomes can be split than cannot.
- RRIFs, for example, can be split on your taxes, even if all the money is pulled from one partner’s account
- Employer pension income can be split up to 50% with your spouse.
- A spousal RRSP allows the higher-earning partner to plan for income splitting by topping up the lower-earning spouse’s RRSP.
CPP income, on the other hand, can be shared but not split. Essentially, that means you can’t decide the percentage split at tax time. Instead, a couple must apply for a certain split (let’s say 30/70). Then, they must live with that same split for their retirement.
A word of caution with income splitting during retirement
Many couples plan to use income splitting as a foundation to fund their retirement. However, if one partner passes away early or the couple separates, no mechanism can replace those savings.
So while income splitting is a great retirement planning tool, it is not assured. Keep that in mind when planning your retirement.