A pension splitting primer

Every week I receive dozens of questions from readers. While I can’t respond to each of them personally, I select several and post the answers in the Q&A section of my Buildingwealth.ca website as well as on the Fifty-Plus site. One of the reasons I do this is that it enables me to stay on top of what people are most concerned about when it comes to money and investing. Right now the top three issues are what to do about bonds, where are the stock markets going, and how does pension splitting work?

The last category should come as no surprise in the light of the 2006 census figures released by Statistics Canada in mid-July. One of the numbers that really stood out was the fact there are now 4.3 million people age 65 and older in this country – that’s one out of every seven Canadians. It’s a safe bet that a large number of these folks, perhaps the majority, are eligible to take advantage of the pension-splitting provisions that were announced on Oct. 31 last year, incorporated into the 2007 federal budget, and which were recently passed into law. Until now, however, there has been virtually no official information from Ottawa on exactly how the program will work.

A few weeks ago, I called the Canada Revenue Agency (CRA) to pass along the frustration that I was sensing from the many questions I received on this topic. I was told at the time that there were no immediate plans to provide any details and that in any event it wasn’t clear whether that responsibility lay with the CRA or with the Department of Finance.

I don’t want to claim cause and effect, but I was gratified to receive a telephone call recently advising me that the CRA was publishing a guide to pension splitting on its website. I checked and, sure enough, it’s there in the form of a 10-point Q&A. Here are some of the key facts I noted in going through the document. You can view the full text at http://www.cra-arc.gc.ca/agency/budget/2007/pension-e.html.

1. The income does not have to be evenly divided. A pensioner can allocate as much as he wants to a spouse, to a maximum of 50 per cent of the total. (Note: whenever I refer to “spouse” it also includes common-law partners of the same or opposite sex.)

2. Separated couples are not eligible. If you’re living apart because of marriage breakdown, you may not split pension income with a spouse even if you are making support payments. There are exceptions for couples who are living separately for “medical, educational, or business reasons”.

3. Unless they are being received because of the death of a spouse, payments from a RRIF or LIF are not eligible for splitting if the recipient is under age 65.

4. The age of the pension recipient determines eligibility. The age of the spouse doesn’t matter, except for claiming the pension income tax credit (see below).

5. Payments from Old Age Security (including the Guaranteed Income Supplement) and the Canada Pension Plan are not eligible. However, the CPP has its own provisions for splitting income with a spouse.

6. Lump-sum withdrawals from RRSPs are never eligible.

7. The 2007 tax guide and return will contain all the information you need to make a pension-splitting declaration. Both spouses must agree to the split.

8. Withholding tax paid on pension income will be allocated between spouses in the same proportion as the income is divided.

9. The rules allow for a “double dip” in claiming the pension income tax credit. Until now, if only one spouse was receiving pension income, a couple could claim only one $2,000 pension income amount. If the income is split, both can make the claim provided they both meet the age requirement.

10. Some tax credits and liabilities could be affected by pension splitting so you need to review all the consequences carefully before going ahead. Among the credits, the age amount and the spousal amount may be reduced or eliminated by shifting pension income to a spouse. The Old Age Security clawback, which comes into play when a person’s taxable income exceeds $63,511, should also be considered. Pension-splitting could work in a couple’s favour here by bringing a higher-income spouse to below the income threshold as long as the other partner isn’t pushed over the limit.

11. The CRA will not allow any reductions in source withholding this year because of pension-splitting nor will there be any change in the amount of quarterly tax instalments you are advised to pay. Of course, you aren’t obliged to pay the full amount of instalments if you decide to use what’s known as a “current-year option” in calculating the amount you owe. But your math had better be right or you risk interest charges.

One point that isn’t absolutely clear from the CRA website is whether the splitting has to go both ways if both spouses are receiving pensions, as is the case with the CPP. I called the Department and they confirmed that it does not – spouses are free to choose which pension money to split.

This article originally appeared in the Internet Wealth Builder, a weekly e-mail newsletter that provides timely financial advice from some of Canada’s top money experts. For more information about becoming an Internet Wealth Builder member, go to http://www.buildingwealth.ca/promotion/50plusproducts.htm