The Elected Split-Pension Amount for retired spouses results in a lower combined Canadian income tax if income can be moved from one spouse’s higher tax bracket to the other spouse’s lower tax bracket. Depending on the incomes, this can be a little hard to determine. This post describes how to determine the best splitting for you and your spouse, provides a spreadsheet to help in the analysis and determines the savings. Be careful when using any optimized amount provided by some of the tax preparation software or the maximum amount permitted as it may not be what you want relative to how much each person pays or receives.
Splitting pension income in Canada has a long history. There are now 3 ways it can be done that help reduce income taxes.
1) Splitting Pension Income – In 2007, the government introduced a option for retired married couples with eligible pension income to move up to half of this income to the spouse with the lower income. This will only result in a lower combined tax if the spouses are in different tax brackets before the splitting. This method of splitting income is the subject of this post.
2) Spousal RRSP – When the Registered Retirement Savings Plan (RRSP) was introduced in 1957, it provided a way to tax-shelter money for retirement and provide a tax refund as well. Starting in the 1970’s an RRSP could be taken out in the spouse’s name to effectively split retirement income. Upon retirement, the payouts are added to the spouse’s income. When converted to a RRIF or annuity, this income can be used for splitting pension income when retired.
3) CPP Sharing – While the CPP was introduced in 1966, only since 1987, and upon retirement, can the retiree ask the government to share the Canada Pension Plan (CPP) payment with a spouse. For details, refer to Canadian Museum of History – History of Canada’s Public Pensions, Pension TimeLine. This sharing is normally done when the spouse has little or no CPP. CPP income is not edible for pension spitting.
4) CPP Credit Splitting – This was introduced in 1978 and permits the splitting of credits earned during the time spouses lived together so that they are equally divided after a divorce or separation. Once this has been done, the CPP payment in retirement is as if each former spouse had the contributions. CPP income is not edible for pension spitting. For details see the Service Canada website or the Government of Canada CPP Credit Splitting Guide .
How Does Splitting Pension Income Work?
Splitting of pension income is started by filling out form T1032 (Joint Election to Split Pension Income). The only restrictions are that the spouses must be living together and be residents of Canada at the end of the year and receive pension income that qualifies for the pension income amount.
In Step 1 of the form one person has to be designated as the pensioner. This person should be the one with the higher income and with some pension income. The other person is referred to as the pension transferee.
In Step 2 it asks for the eligible pension income that is calculated on the Federal Worksheet for line 314 for the pensioner. This is the same line that is used to determine if you can claim up to $2,000 of the Pension income amount on Schedule 1 in the Federal non-refundable tax credits area. Up to 50% of the eligible pension amount can be used for pension splitting.
In Step 3 you decide how much of this 50% is to be used. Splitting is accomplished by using this amount on each person’s T1 (Income Tax and Benefit Return): add it to the transferee’s income at line 116 and subtract it from the pensioner’s income at line 210. The amount on line 260 (Taxable Income) will thus be adjust up or down by this amount. Setting this value is discussed in more detail below.
In Step 4 you determine how much can be used for line 314 (Pension income amount) on both of your forms. The maximum is $2,000. Make sure that the value set in Step 3 is enough for both of you to claim the $2,000. This basically means that both of you do not incur any tax on the first $4,000 of pension income.
Step 5 is to be used to move any eligible tax deducted from the pensioner’s (higher income spouse) to the transferee’s (lower income spouse). It uses the amount used in Step 3 divided by the 50% amount to calculate how much the pensioner’s line 437 (Total income tax deducted) is to be reduced and how much the transferee’s line 437 is to be increased.
Setting the Elected Split-Pension Amount
The following are a few ways to set the split-pension amount:
1) Ensure that both spouses take advantage of the non-refundable tax credit of $2,000 on line 314 (Pension Income Amount) on the Federal Schedule 1. There is also a similar (but lower) amount on Provincial tax returns.
2) Move the lower income spouse up towards, but not into, the next tax bracket. This will reduce the higher income spouse’s taxes at the higher rate but the lower income spouse’s taxes will increase by a smaller amount due to the lower rate.
3) Move the higher income spouse down at least one tax bracket. This will reduce the higher income spouse’s taxes because the rate is lower but the lower income spouse’s taxes will increase probably by a smaller amount due to the initial lower rate.
4) Use the Optimization feature of some software products. This will find the lowest total taxes but it may affect who pays the balance or receives the refund in a way that may be unacceptable.
5) Move the higher income spouse’s income down if it exceeds the Old Age Security Clawback amount. For 2014, this is $71,592 and is calculate in the Federal worksheet for Line 235. Any income above this value incurs an additional 15% tax.
Which method works best for you depends on the income of each spouse, where they fall within the tax brackets, how much can be moved and how much of the refund or balance you want for each spouse.
There are additional factors that also must be considered. For example, if both spouses are in the same tax bracket, there may not be any advantage to splitting the pension income, but the provincial tax brackets will also have an effect. Similarly, the deductions and additional taxes imposed at the provincial level (such as Ontario’s Health Premium) may come into play.
Keep in mind, that after all of this splitting has been done, you may need to adjust which spouse claims certain deductions. For example, it is usually best for the higher income spouse to claim the Charitable Donations and the lower income spouse to claim the Medical Expenses.
Undesired Effects of Pension Income Splitting
Depending on the relative difference between the spouses income before splitting, you may get some unwanted results. For example:
– Reverse Higher Income – The maximum splitting may reverse who is now the one with the larger Taxable Income. This is not normally what you want, so choose the splitting value carefully. You can see when the incomes reverse by either examining the Line 260 values or using the chart provide in the spreadsheet (see below) that shows these values.
– Too High an Instalment – The Payable Taxes by one person may be more than you want because it will require too high an instalment next year.
– Too High a Balance – The Return or Balance may now be too high for one person at the expense of the other. For example, one person may get all the refund and the other will have to pay all of the balance instead of both getting a refund. This is also shown in the spreadsheet charts and table.
Any of these conditions may be enough to have you forgo a few dollars from the splitting that give the highest savings.
Determining the Best Split-Pension Amount
The best way to determine if there is an advantage to splitting pension income is to try a few values, record the results and compare the taxes and refunds that result.
This analysis is very difficult to do directly on the tax forms as each change requires redoing all of the forms. It is much better to use one of the many products that have been certified by Canada Revenue Agency because they do all the calculations and fill out the forms automatically. Many are free to download or use online. You usually only have to pay when actually filing. Once you enter enough information you can then try a few options on the included form T1032 and see what happens on the T1 and Schedule 1 forms.
I have provided a spreadsheet that you can download by clicking on Download Pension Splitting Spreadsheet. Also, open the tax preparation software and enter everything for you and your spouse, except the information for the T1032. The spreadsheet is loaded with the values for the example below. To clear them for your own values, select the cells from B6 to G12 and clear the contents (Edit > Clear > Contents).
Example of Splitting Income Pension
The following example illustrates the use of the spreadsheet and how to obtain the values for the Elected Split-Pension Amount. It is for a retired couple living in Ontario with the pensioner having $40,000 pension income, $30,000 investment income, $7,000 tax deducted and $8,000 paid by instalments. The transferee has $35,000 investment income and $4,000 paid by instalments. These have been chosen to illustrate using 5 values for the Elected Split-Pension Amount.
These values were entered into TaxTron and the spreadsheet was filled for all of the conditions given below. It looks like this:
There are 3 line scatter charts along the left side of the spreadsheet that have lines for each spouse: 1) Taxable Income, 2) Total Payable Taxes, 3) Refund or Balance. There are also 3 charts to the right that show: 1) Savings in Combined Total Payable Taxes, 2) Combined Total Payable Taxes and 3) Combined Refund or Balance. These are as follows:
To see the table or charts in a larger size, right-click on it for Windows or control-click on it for Macs and open in a new tab or window .
The following describes how to use the spreadsheet, what values to enter into each of the rows and the analysis for the example. Use the T1 forms for both spouses to obtain Lines 260, 435 and the Refund or Balance which you enter on the appropriate row.
1) Zero – Do not transfer any amount (use a zero amount) and record the 7 items shown in the table into the column marked as Zero. The 4 totals will automatically be calculated and the charts will show one point. To do this, open form T1032 and enter 0 in Line G. Then use the T1 forms for both spouses to obtain Lines 260, 435 and the Refund or Balance which you enter on the appropriate row.
For the example, this results in a combined refund of $205 almost equally divided between each spouse.
2) For $2,000 – Use the minimum amount of splitting so that both spouses can claim the $2,000 Pension income amount of line 314. To check if the $2,000 is being used, look at the Schedule 1 form for both spouses. If it is below $2,000, return to T1032 and enter enough to make each person have $2,000. Record all 7 of the values given above in the column marked “For $2,000″. If no value is used, copy the Zero column into the For $2,000 column or leave blank.
For the example, the combined refund jumps to $720 with the pensioner getting about 60%, due to the transferee getting $2,000 and the pensioner’s income dropping by $2,000.
3) Move Up 1- Determine how much is needed to move the lower income spouse’s Taxable Income (Line 260) to the upper limit of the present tax bracket. You can see what bracket is being used by looking at line 40 of Schedule 1 for the transferee or the appropriate provincial 428 form. If transferee’s income is below the tax brackets upper limit, then use a value for the split-pension amount needed to get to this limit (i.e. upper limit – Zero line 260 income = split-pension amount). Enter this amount into Line G of T1032. This will effectively reduce the taxes to be paid by the difference between the higher income spouse’s tax rate and the lower income spouse’s tax rate times the split-pension amount. Fill in the values in the column on the spreadsheet labelled “Move Up 1″.
For the example, the next bracket for the transferee is the Ontario value of $40,120 as shown on form ON428. Tax brackets for all provinces are given in Canadian Marginal Tax Rates – 2014. The combined refund increases again by another $246, but this time the pensioner gets almost all of it. The drop in pensioner income results in most of the savings.
4) Move Up 2 or Move Down 1- Normally it is possible to move the lower income spouse up one more bracket before moving the higher income spouse down one or more tax brackets. If moving up, use the same method as given in 3 for the next federal or provincial tax brace for the transferee. If moving down, use the lower limit for the pensioner’s tax bracket as follows: lower limit – Zero line 260 income = split-pension amount. Whichever is next, use the “Move Up 2 or Move Down 1″ column. If it is not possible, delete the column or copy the Move Up 1 values so that the chart lines will be continuous.
For the example, Move Up 2 is used and the header is bolded. The combined refund is now at its highest of $1,234. However, the transferee now has to pay a balance of $322. If this is not acceptable, the Elected Amount can be adjusted to $5,640 so that there is no payment or refund by the transferee. In this case (not shown on the table) the combined refund is $1,004 which is a little better than the Move Up 1 savings. Is the loss of $230 in combined refund worth not having to pay something for the transferee? In this case it is not very much of a Balance to gain the $230, but there are cases where the Balance is very high and the loss is not very much.
5) Optimize – If the software program you are using has an Optimize Pension feature, use it and take the value it offers. Enter it and the other 6 values into the “Optimized” column. If it does not offer this feature, try a few values in T1032, Line G to see what happens. If you can find an better value that any of the ones above, enter the 7 values into the Optimized column.
For the example, TaxTron gives an optimize amount of $9,080 which is $127 more than the Move Up 2 amount. It has the same Combined Refund but the pensioner gets a few more dollars back ($21) and the transferee has to pay the same amount. This shows that that the Optimized amount is not as good as the Move Up 2 amount in reducing what the transferee pays.
6) Maximum – Enter the maximum amount of Line F shown on the T1032 form into Line G. Using the T1 forms, fill in the values under the column and record the values in the “Maximum” column.
For the example, this requires the transferee to pay lot of money, $2,312, for a combined refund that is $150 below the highest savings of the Move Up 2 amount. This shows that it pays to find the amount that gives the highest savings rather than taking the maximum amount.
You can add as many columns as desired, if more values are to be evaluated (such as could have been done to show the amount needed for no balance for the transferee). Just copy a column and insert in the appropriate place between the Zero and Maximum columns.