Income Splitting and Free Vacations

The Financialist • Issue 107 • October 2010

BY ALAIN QUENNEC BComm CFP FMA CIM

Under the Canadian system of progressive taxation, the tax we pay on our last dollar of income is greater than that on our first dollar of income. This is called a progressive tax system - the rate of taxation becomes progressively higher the more you earn. Wouldn’t it be nice to pay a lower rate of tax on some of your income?

While there have been, for many years, several ways for Canadian residents to split income, we’ll begin by focusing on one significant development of the last few years - pension income splitting.

THE FACTS

It has always been possible for retired couples to split their CPP credits and benefits, based on the length of the marriage. But since the 2007 tax year, additional forms of income can be split (to a 50% maximum) between spouses (a spouse as defined for tax purposes includes a common-law partner) to lower the amount of tax paid by the family.

Up to 50% of income from an employer pension plan can be split with a spouse while the pensioner is collecting. Up to 50% of regularly scheduled income from a RRIF or LIF can also be split, as long as the person doing the splitting is at least 65 years old. There are no age restrictions on the recipient.

CASE STUDY FOR DOUG AND CARRIE

Doug, 65, and Carrie, 63, are both retired and collecting pensions from past employment, as well as drawing RRIF income. Doug’s RCMP pension is $48,000 and he draws $12,000 annually from his RRIF; his government benefits then bring his total taxable income up to $67,000. Carrie’s pension from part-time teaching is $10,000 and she draws $3,000 annually from her RRIF; her total taxable income (including government benefits) is $17,000.

Doug is paying 30% income tax on his income between $41,000 and $67,000. Under the income splitting rules, he can elect to have Carrie (if she accepts) pay the tax on up to half of his pension income and scheduled RRIF withdrawals.

Doug and Carrie should make the election to split $24,000 of Doug’s pension and $2,000 of his RRIF income to Carrie, so that he can avoid paying 30% on that income while Carrie pays 20% on $19,000 of it and 23% on the remaining $7,000.

The tax savings to Doug and Carrie is $2,390, enough for a one week getaway at a 4-star resort in Mexico... they can do this every year!

Taxation and income splitting isn’t the most interesting topic at social gatherings, but this is, nonetheless, one of the most important pieces of legislation to be passed for seniors in many years. The potential tax savings are enormous, given our experience of seeing many retired couples with lopsided incomes. It’s rare for both spouses to be in the same marginal income tax bracket.

WHAT TO WATCH OUT FOR

I hope you didn’t think this benefit came without potential pitfalls.

Let’s fast forward to the year 2015. Carrie is now in a government-subsidized long term care facility, recovering from a stroke. Doug may choose to stop splitting his income with Carrie, as it would otherwise reduce Carrie’s subsidy benefit.

A subsidized facility will charge the patient based on the income level reported on his/her tax return, and the subsidy lost may be greater than the tax savings. 

The following table illustrates the income tax burden experienced by a BC resident taxpayer (all figures approximate):