What is pension income splitting?

Pension income splitting is one of the tax breaks for retired couples. It allows a spouse to transfer up to 50% of the their eligible pension income to their spouse for tax purpose. No funds are actually transferred when using pension income splitting. It is just a way to reduce some pension income from one spouse’s tax return by allocating it to the tax return of the other spouse.

If the pensioner is in a higher marginal tax bracket than the spouse, the pension income splitting will provide tax savings. If both spouses are in the same tax bracket, income splitting may still be useful if it creates or increase a pension income tax credit.

Although the maximum amount can be transferred is 50% of the eligible pension income, the optimal allocation (the amount that can achieve the highest tax savings) is usually less than the allowable 50% maximum. The best way to figure out the optimal amount is to use tax software.

To qualify for income splitting, the pension income must meed certain conditions. The 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 out of or under a Registered Retirement Income Fund (RRIF). Eligible pension income doesn’t include payments under the Canada Pension Plan (CPP) or Old Age Security (OAS) payments.

The transfer must be agreed to by both spouses and a special election form (Form T1032 – Joint election for pension splitting) must be filed with the tax returns. If the tax returns are filed electronically, signed Form T1032 must be kept on file in case the Canada Revenue Agency (CRA) asks for it.

Withholding taxes related to the transferred pension income will be transferred to the spouse, proportional to the amount of income being split. For example, if 30% of pension income is transferred, 30% of the withholding taxes will also be transferred.

Example: Your total income is $80,000, of which $50,000 is eligible pension income. Your spouse has no pension income and only $8,000 in other sources of income. You can transfer up to $25,000 of your pension income to your spouse. You will report taxable income of $55,000 and your spouse will report taxable income of $33,000. Both of you can claim the pension income credit. The combined taxes are much lower when splitting income.