Split your income, save tax
Accountants say recent change is a ‘huge’ gift New regulation adds to benefit of spousal RRSP
Toronto Star, Talbot Boggs
Changes to federal tax regulations that affect pension income splitting have gone largely unnoticed by Canadian taxpayers because of all the attention paid to new laws taxing income trusts, some financial experts say.
On Oct. 31, federal Finance Minister Jim Flaherty released the government’s new tax fairness plan. The plan laid out a number of tax initiatives, including a tax on distributions from publicly traded income trusts and new rules regarding income splitting for Canadian pensioners.
“They (the rules on income splitting) have been overshadowed by all the commotion over the taxing of income trusts,” says Cynthia Kett, a chartered accountant and certified financial planner with Stewart and Kett Financial Advisors Inc.
“Accountants and financial writers are touting these changes (to pension income splitting) as huge, but they have not been publicized that well,” Kett says.
Kett calls the new income splitting rules a “gift” from the government. “The potential is huge and will have more impact on financial planning than the changes to income trusts,” she says.
Income splitting is a way to reduce a family’s overall tax bill by shifting income from a higher-income earner to one or more lower-income earners so the total family income is taxed at a lower rate, or not at all if the lower income earner’s income is small enough.
Under the new rules, any Canadian resident who receives income that qualifies for the existing pension income tax credit can allocate up to 50 per cent of that income to their resident spouse or common-law partner.
For example, an individual in Ontario earning $100,000 a year would pay $29,418 in tax. If the income was split among two people, each would pay $10,187 in tax for a total of $20,374, a tax saving of $9,044 a year.
In the past, Canadians have been able to split income through the use of spousal registered retirement savings plans.
Canadian taxpayers were first allowed to contribute to spousal RRSPs in 1991. Under this strategy, a wage earner can allocate RRSP contributions to an RRSP owned by a spouse or common-law partner up to the maximum allowable amount, or 18 per cent of earned income from the previous year, less the previous year’s pension adjustment, to a total of $18,000. The contributing spouse receives the deduction from his or her taxable income.
Some people have questioned whether the new rules make the use of spousal RRSPs obsolete.
“Not really,” says Dave Ablest, senior vice-president and retirement planning specialist with Investors Group. “Spousal RRSPs still provide income splitting opportunities for people under the age of 65.”
“Spousal RRSPs still make sense for people who are looking for a tool to help them minimize their tax bill or who want to retire early,” says Patricia Lovett-Reid, a senior vice-president at TD Waterhouse.
“The new rules level the playing field by now giving pensioners a chance to manage their tax situation better and a choice of who has what income in retirement,” Lovett-Reid says.
“It’s a very powerful change.”
Income splitting provides the most benefit to families in which there is a large difference in income levels among its partners. It does not benefit single retirees or couples whose incomes are in similar tax brackets.
Kett advises people to look at the different methods of income splitting in the context of their overall financial situation. “It’s an opportunity, not a panacea,” she says. “It’s something people have to look at year after year.”
For people 65 and over, eligible pension income includes lifetime annuity payments under a registered pension plan, RRSP or a deferred profit-sharing plan, and payments out of or under a registered retirement income fund.
For people under 65, eligible pension income includes lifetime annuity payments under a registered pension plan or other payments received as a result of the death of a spouse or common-law partner.
The government says the new pension income splitting measures will provide Canadians more than $1 billion in tax relief each year. The changes will be in place for 2007 and subsequent years and must be made one year at a time.