Income splitting rules help retired couples in which one spouse has a distinctly higher pension income than the other.
Spouses have been able to split eligible pension income for income tax purposes since January 1, 2007. This provides a sizeable tax benefit to many retired couples where one spouse has significantly higher pension income than the other.
Most provinces have similar income splitting rules. Alberta is one exception as it has a flat tax rate.
For some time, couples have been able to split their CPP/QPP payments if they wished. Now, if you're a retired Canadian resident, you can also allocate to your resident spouse or common-law partner up to one-half of any other pension income that qualifies for the pension income tax credit.
For income tax purposes, the amount allocated will be deducted from your income and included in the income of your spouse. By doing this, you and your spouse will be able to reduce your overall household tax bill. It is estimated, for example, that a retired couple where one spouse has eligible annual pension income of $40,000 and the second spouse has no income could achieve a $2,500 tax savings by splitting the pension income.
The types of pension income eligible for income splitting vary depending on your age. For people age 65 and older, eligible pension income includes lifetime annuity payments under a registered pension plan (RPP), a registered retirement savings plan (RRSP) or a deferred profit sharing plan (DPSP), and payments from a registered retirement income fund (RRIF). For individuals younger than 65, eligible pension income includes only lifetime annuity payments from an RPP (employer-sponsored pension) and certain other payments received upon the death of a spouse or common-law partner.
Some analysts suggested this income splitting opportunity would cause the demise of spousal RRSPs. However, depending on the mix and type of income you and your spouse will have in your retirement years, a spousal RRSP could still be a worthwhile income splitting tool.
With a spousal RRSP, one spouse or common law partner owns the plan while the other spouse/partner contributes the funds to it. When funds are withdrawn in retirement, the funds are taxed in the hands of the partner who owns the plan, not those of the contributor. If the owner of the plan is in a lower tax bracket than the contributor, significant tax savings can be achieved on the couple's combined total tax bill.
So, you should still consider having a spousal RRSP even if you plan on retiring before age 65 when eligible pension income only covers RPPs and payments received upon the death of a spouse.
Also, for taxpayers who have accumulated a healthy non-registered investment portfolio, a spousal RRSP could be one way to divert investment capital to the spouse to achieve a balancing of income in retirement.
Of course, the pension income splitting rules do not benefit all Canadian retirees. Those who are single or widowed, couples with pensions of comparable amounts, and households where each partner has more than $32,406 in income (top tax bracket) or less than $42,707 income (lowest tax bracket) will not benefit from pension income splitting.
That being said, many pensioners in Canada will be saving on their tax bills due to the new splitting of eligible pension income.
Considerably more Canadians could be saving tax dollars if the government decides to give all couples the opportunity to average all other types of income between them. Other countries, such as the U.S., France, Germany, and Switzerland, already have some method of total income splitting in place. In the U.S., for example, couples have the option of filing either joint or separate tax returns.
Depending on the situation for different couples, the benefits of general income splitting could be quite different. Generally speaking, middle-income earners would benefit more, because income splitting allows you to pay less tax only on the first $132,406 of income. Also, the amount of savings relates to what each partner's tax rate would be if they didn't average their income.
For example, consider a couple where one spouse earns $100,000 and the other has no income. With general income splitting the breadwinner would see federal taxes drop by almost $3,500 (without considering non-refundable tax credits). On the other hand, in a family where one spouse earns $70,000 and the other earns $30,000, the tax benefit is only about $430.
A move to general income splitting would be very expensive for the Canadian government. The move would lead to an estimated $5 billion in lost revenue each year. In addition, it would not make singles happy since they would not benefit. And, some women's groups suggest it would provide a disincentive for women to stay in the workforce because it would reduce the tax burden in families with a stay-at-home spouse.