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How to Make the Most of the Pension Income Tax Credit Thumbnail

How to Make the Most of the Pension Income Tax Credit

Retirement Funding Taxes

When and how to retire is a major decision. 

Some choose to exit the workforce at age 65 and jump right into retirement while others prefer to move to part-time work, or even continue working for years after they are financially secure enough to retire.

However you choose to do it, the transition from income-based living to savings-based living can be a challenging one – especially because optimizing every expenditure suddenly becomes much more important.

Subsequently, proper tax planning is essential as you move toward, and into, retirement. 

The good news is, as you move away from the workforce, new opportunities for decreasing your tax burden open up, including the Pension Income Tax Credit. 

However, in that transitional phase between retirement and semi-retirement, accessing those opportunities can be difficult to navigate.

To help you make the most of your Pension Income Tax Credit, we’ll cover the ins and outs of what it is and how you can access it to lower your taxes.

What is the Pension Income Tax Credit?

Available to those aged 65 (or turning 65 during the tax year) or over, the Pension Income Tax Credit allows retirees to reduce their tax burden on income from certain pensions. Both federal and most provincial/territorial governments (excluding only Quebec) offer their own version of the Pension Income Tax Credit, which allows you to save on both federal and provincial taxes.

Before we get into the specifics of each, it’s important to point out that this tax credit is non-refundable. That means you can only use it to lower your income tax bill to zero, not increase your tax rebate. Also, it cannot be carried forward year to year.

Federal Pension Income Tax Credit

The national version of the credit reduces your tax payable by 15% on up to $2000 of eligible retirement income. That equals $300/year ($2000 x 15% = $300) off your income tax. 

  • Covers the first $2,000 of eligible pension income
  • Maximum savings of $300/year
  • Doesn’t carry forward
  • Can only subtract from taxes, not add to tax refunds

Provincial Pension Income Tax Credit

The provincial version changes depending on the province in which you live. In Manitoba, the tax credit can be used on the first $1000 of your pension income to lower your tax bill by $108.

  • Different amounts in each province/territory
  • Unavailable in Quebec
  • Doesn’t carry forward
  • Can only subtract from taxes, not add to tax refunds

Pensions that qualify

Not all retirement income qualifies for the pension income tax credit. In fact, income from one of the most popular retirement savings vehicle, the RRSP,  is not included.

Qualifying incomes include:

  • Life annuity payments from: 
    • Superannuations or pension plans (including the Saskatchewan Pension Plan)
    • Retirement Compensation Arrangements (RCA)
    • Registered Retirement Savings Plans (RRSP) 
  • Payments from: 
    • Pooled Registered Pension Plans (PRPP)
    • RRIFs, LIFs, RLIFs, LRIFs or PRIFs
  • Deferred Profit Sharing Plan (DPSP) annuity payments
  • Regular annuity or income averaging annuity contract payments
  • Certain foreign pension plan (including the taxable portion of the U.S. Social Security) payments
  • Split pension income

Non-qualifying pensions include:

  • Old Age Security (OAS)
  • Canada Pension Plan (CPP) 
  • Quebec Pension Plan (QPP) 
  • Death benefits
  • Retirement allowances
  • RRSP withdrawals (except annuity payments)
  • RRIF income that has been transferred to another RRIF, an RRSP or an annuity
  • Tax-free foreign pensions
  • Individual Retirement Accounts (IRA)
  • Salary deferral income

Make the most of your RRSP

If your main retirement income comes from one of the included pensions, then making use of the tax credit is easy. However, if most of your savings are kept in an RRSP, you can’t make use of the Pension Income Tax Credit:

  • Until 71 when you have to transition your RRSP into a RRIF
  • Unless you transition some funds from your RRSP to a RRIF early

Converting to a RRIF

For many people between the ages of 65 and 71, converting some of your RRSP to a RRIF makes sense. However, this does come with stipulations, including the requirement to take money out, and the inability to put money into a RRIF.

The best way to do this is to convert only the amount that qualifies under the provincial and federal tax credit from your RRSP.

EXAMPLE

A 65-year-old woman in Manitoba would convert $12,000 of her RRSP into a RRIF the year she turns 65. This allows her to withdraw $2000 each year to save $300 on federal tax and $108 on provincial tax. Then, at age 71, she would transfer the rest of her RRSP into a RRIF as required by law, enabling her to continue to receive the credit.

That’s a $408 savings on taxes each year providing you are not expecting a refund.

But be aware as this plan can affect other benefits, such as Old Age Security.

Tips to leverage the Pension Income Tax Credit

Another benefit of the Pension Income Tax Credit is that it allows for income splitting. So, a 68-year-old retiree who does not expect to pay much income tax can split it with a partner (even if they are under age 65) to make the most of the tax credit.

If you’re curious if converting your RRSP to a RRIF early is right for you, please get in touch. We’ll walk you through the process so you can come up with the best plan for your unique retirement situation.