Unintended consequences of pension income splitting in BC
In 2006, the federal Finance Minister announced the introduction of Pension Income Splitting for senior taxpayers. At the same time, the government was closing loopholes that allowed companies to function as income trusts and, as a result, many seniors found themselves with investments paying out less income. It appears the pension income splitting measures were intended to compensate for some of that lost income – if you qualified.
Not all pensions are eligible for income splitting. Canada Pension Plan and Old Age Security are not eligible in this program, though you may be able to split your CPP payments if you talk to Service Canada. If you are 65 or older, you can split RRIF withdrawals, registered annuities and the interest portion of non-registered annuities, as well as periodic payments from a private pension plan, including foreign plans. If you are younger than 65, RRIF payments and annuities only qualify if you are receiving them due to the death of a spouse. Retiring allowances, death benefits and lump-sum commutation payments do not qualify, regardless of your age.
Seniors need to file a T1032 Form, Joint Election to Split Pension Income, with their tax returns to split eligible pension income between two spouses. The most tax savings are achieved when one spouse earned the majority of the income and the other had virtually no income. This is especially beneficial if the person receiving the income would otherwise be subjected to the clawback of Old Age Security (OAS) benefits.
For example, if a husband receives an annual pension of $50,000 from his company and his wife has no pension plan because she chose to stay at home, the husband could transfer $25,000 in income to his wife’s return. This means the entire $50,000 is taxed at the lowest tax rate and the couple saves money. Even if both spouses have the same income, they may be able to benefit from income splitting if they are not both fully using their pension income amount. It seemed like a “win-win” for everyone and I have seen seniors save up to $3,000 in taxes when they choose to split their income.
In B.C., however, we are now beginning to see some unintended consequences of moving income from one spouse to another. For example, when one spouse has an artificially inflated or phantom net income on the tax return this may be used to determine other benefits, including the cost of a subsidized care facility.
If the lower-income spouse needs to go into a care facility or home, the costs are calculated based on the now-inflated net income. In some cases, the pension income split can end up costing more in care-facility fees than it actually saves in taxes. Local health authorities have been reluctant to reverse the higher home-care fees for the lower-income spouse even when they have revoked the election.
On the flip side, if the higher-income spouse is the one in the care facility then pension income splitting with their lower-income spouse will bring their costs down.
It is not uncommon for spouses to declare themselves “involuntarily separated” when one is in a care facility. This does not affect their marital status on their tax returns but does allow the spouse in care to continue to receive the Guaranteed Income Supplement (GIS) that is used to pay for their care costs.
Pension income splitting may also cause problems where the spouse who is in the care facility is receiving the Guaranteed Income Supplement (GIS). This is because benefits are initially based on individual net income as opposed to family net income. However, taxpayers in this situation may ask Service Canada to have their entitlement re-calculated with the split-pension income amount excluded from their income.
Every situation is unique and many seniors can experience a life-changing event in less than a year. Taxpayers in B.C. choosing pension income splitting should assess their health situation and explore the additional costs they may face if they need to enter a care facility.
Article courtesy of H&R Block Canada. For additional information or other tax tips, phone 1-800-HRBLOCK or visit www.hrblock.ca.