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How to lower your taxes in retirement with income splitting Thumbnail

How to lower your taxes in retirement with income splitting

Now that you’re retired, you have a fixed amount of money to use for the next 30 (or more) years. That bank account doesn’t ebb and flow anymore, it only drains. 

Slow spending is the only way to ensure you will have the money you need to enjoy your retirement. That means making hard decisions about where you’re choosing to spend your money.

For the right couple, income splitting can help you save money without affecting your lifestyle.

To help you understand if you and your partner can benefit from income splitting, we’ll cover how it lowers taxes, and how you can leverage it to make your retirement easier.

What is pension income splitting?

Income splitting is simply allocating a portion of your income to your spouse or common-law partner for tax purposes. This split does not have any effect on where the money goes or who can spend it. It only affects how the CRA views your income as individuals.

For some couples, this can help lower their tax burden come April. However, the benefits of income splitting extend beyond personal income tax.

Why you should income split

  • By allocating more income to the lower-earning partner, you may be able to drop into a lower-income bracket
  • You can use it to give the Pension Income Tax Credit to the lower-income partner or increase your partner’s pension tax credit. To do this, the partner receiving the pension income needs to be under 65. This would allow the receiving partner to declare $10,000 in pension income and claim the full Pension Income Tax Credit ($2,000), which would reduce their tax by $300. 
  • You can restore your Old Age Security (OAS) or Age Amount Credit by reducing or even eliminating clawback.

An example of tax savings through income splitting

If you, as the higher-earning partner, make $125,000/year in 2024, you’re paying 43.4% combined federal and provincial (in MB) tax rate on everything over $111,733. If your partner makes $60,000/year, they are only paying a 33.25% combined tax rate, with $51,733 worth of room before they start paying the higher 37.9% tax rate.

If you have up to or over $26,534 in eligible pension income, you can allocate $13,267 to the lower-income partner and pay 10.15% less tax on that income. 

This will save you around $1346.00 come tax time.

How to income split

First, you need to have your partner's consent, i.e. you can’t unilaterally decide to split income with your partner. 

Then, it’s as easy as filling out the Joint Election to Split Pension Income Form (Form T1032 – Joint Election to Split Pension Income) for both you and your partner’s tax returns.

Rules for income splitting

While the idea is straightforward, in practice income splitting is more complicated. There are many stipulations about how it can be done, and with what income money it can be done. Today, the rule with the biggest impact is that you can only income split with retirement income.

Generally, you or your partner can allocate up to 50% of the eligible pension income to the other partner. Both partners are not allowed to income split in the same year. However, your choice does not have to stay the same year to year. Each year, you choose which partner will split their income and by how much.

While income splitting is restricted to retirement income, not all retirement income is eligible.

What is eligible income for splitting?

Income eligibility is based on income type and the age of the transferring partner. The age of the receiving partner isn’t relevant for eligibility (though it may have some effect, including on the Pension Income Tax Credit as mentioned earlier).

The most common types of income you are allowed to split include:

  • RPP (Registered Pension Plan income) payments 
  • RRIF (Registered Retirement Income fund payments) payments 
  • RRSP (Registered Retirement Savings plan income) income 
  • Foreign pension payments

For a complete list of eligible income, head over to the Canadian government website.

Adding up all income from those income streams will give you the total amount of eligible income available to share – up to 50% of this total amount can be split with your partner.

What retirement income is not eligible for splitting?

Ineligible income includes any payment from:

  • Old Age Security (OAS)
  • Canada Pension Plan (CPP) 
  • Quebec Pension Plan (QPP)
  • Foreign pensions that are tax-free in Canada because of a tax treaty
  • American Individual Retirement Account (IRA)
  • A RRIF included on line 11500 of your return and transferred to an RRSP, another RRIF or an annuity

Make the most of income splitting – talk to a financial planning expert

Depending on your – and your partner’s – age, and your savings, income splitting can be a great tool to help you keep more money in your account during retirement.

For more detailed information on how you can leverage income splitting and make the most of your retirement, talk to a financial planner.