Income Splitting Strategies in Retirement

If you could split your income with your spouse, there is a pretty good chance you could drastically reduce your tax bill.  In this episode, I show you how that will be possible for you in your retirement years.

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Transcript

Speaker 1: 0:09

Hello and welcome back to the Canadian Money Roadmap Podcast. I'm your host, kevin Newfield. On this week's episode, I'm answering a question that I got recently about income splitting. This is the idea that you're able to share some of your income with a spouse to hopefully pay less tax. Here in Canada, we don't have too many opportunities to reduce our tax bill based on the fact that you're married or a common law while you are still in your earning years. That might be different than some of the things you see online. I don't know what it's like in the US. Some states might be different. That way, if you're able to share income, you hear the line of people saying I got married for the tax benefits. It's not really that great in your earning years. But in this episode I'm going to be talking about some things that you can do and some income types that, if you have them, you can actually share them in retirement. This is one of the concepts that people really latch onto when they're describing how you're likely to pay less taxes in retirement, and let's get right into it.

Speaker 1: 1:17

Let's start with a little bit of specifics on taxes and how that really works. Here in Canada, we have something called the progressive tax system where the more money you make, the more tax you pay. That just scales up with the different tax brackets. The more money you make, the more your average tax rate is going to be. Let's just use a real example here for someone that's in Ontario. If you are a single person in Ontario making $150,000, you'd pay about $42,000 in taxes. Now that is just back of the napkin. That does not factor in deductions or credits or anything else. This is just rough and dirty in a vacuum. How much you'd pay in taxes? So $150,000, you'd pay $42,000 in taxes. However, say you were in a couple or whatever. Just two people earned half that gross. So $75,000 before taxes, they would pay a total of $28,000 in taxes. So if income splitting was possible let's say there was a situation where that $150,000 earner was married and their spouse was a stay-at-home parent or something like that If they were able to split that $150,000, 50-50 with their spouse, it'd save about $14,000 per year in taxes.

Speaker 1: 2:33

So you can see why income splitting during the earning years isn't likely to come our way anytime soon. Who knows, there's an election coming up and you'll start to hear all sorts of crazy things. Maybe this is one of them. I doubt it, but maybe so. Even though this isn't possible during your earning years, here's the good news Certain types of income at certain ages can be split to take advantage of this. So there are a million different things, that types of income and situations you can be in that you probably haven't even thought of, and every time I look this up, there's situations that I haven't thought of either. So I'm just going to focus on a few of the key ones instead of addressing every possible situation.

Speaker 1: 3:12

So in Canada, the main income splitting opportunity is more accurately called pension income splitting. And the devil's in the details here, because certain types of income are considered pensions and others are not. Here are the two big ones. The first one, a defined benefit pension, and so this is what you think of when you think of a pension. So if you're, say, a teacher or a nurse or something like that, you work in the public sector. If you receive a payment for the rest of your life as part of your benefits, that is called a defined benefit pension. If you have a defined benefit pension at any age, you can share that with your spouse. That's pretty cool. You don't have to be a specific age or anything like that. Defined benefit pensions really get this cool treatment. The vast majority of pensions you cannot start claiming until 55. I've seen a few situations where it's different than that, but for most people that have a pension, they wait until they've reached their un-reduced pension amount. That's usually a combination of things like your age plus the years you worked has to equal something like 80 or 82 or something like that, and so many people will start claiming their pension at that point. Lots of people will continue working after that, but just that pension amount is able to be split with a spouse.

Speaker 1: 4:30

The next one that more people these days are going to have at their disposal is something called a RIF, a registered retirement income fund. Now let's backtrack a little bit. So an RSP I was explaining an RSP is like a bucket and once you get to a certain age, your RSP has to turn into something called a RIF. That is at age 71. You have to convert it to a RIF at that point. So again, an RSP is a registered retirement savings plan, that's your bucket, and then it converts into a RIF, that's a registered retirement income fund. And if your RSP is a bucket, then a RIF is a bucket with a hole in it. The reason I say that is that a RIF has a minimum amount that you have to withdraw from it every year. There's no lid on the top, though, so you can take out as much as you want, but there are minimums that have to be withdrawn, and that amount changes every year with your age, and I'm not going to get into that here. But if you are at least age 65, so, again, you can convert your RSP to a RIF whenever you want, but that minimum payment has to come out whenever you convert it to that RIF.

Speaker 1: 5:40

Okay, so if you have a RIF after age 65, you can split that income with a spouse. So let's use this hypothetical again. So if you are now 65 years old and you have a pile of money in a RIF and you take out $150,000, when you file your taxes, half of that. So you can split up to 50% of your pension income. Again, a RIF is considered pension income. In my hypothetical, if you had $150,000 that came out of your RIF, you could actually claim it on your tax return as you having $75,000 and your spouse having $75,000. Boom, saved you $14,000 in taxes. It's pretty cool. So this is one of those situations where it makes it really, really clear how you're able to save on taxes when you're retired.

Speaker 1: 6:28

Now, I use the word retired even though it has nothing to do with being retired. It has everything to do with being age 65 or older. Okay, the vast majority of people are not going to be withdrawing from their RSPs unless they have to if they're still working, and so that's why we often put RIF income and being retired hand in hand, but it's not mandatory. So here's a few things that you want to keep in mind. To clarify some things If you're 65, you can split up to 50% of your pension or your RIF payments with your spouse, and again, just 50% and just pension income.

Speaker 1: 7:03

So let's give an example here. Say you had a defined benefit pension and you had some RIF money all in your name and you're working a part time job. Many retirees end up doing that either just for fun or to stay busy or whatever. This maybe sounds a little bit niche, but I've seen it many times before and so who knows, it could happen to you. So in this case again, defined benefit pension and RIF money and part time employment this person could split 50% of the pension, 50% of the RIF and none of the employment income, regardless of the age. So because you have employment income, the earner in this example is going to have a higher tax rate because you can't split more than 50% of your other sources of income. So the pension and the RIF to offset the employment income. So the person who earns employment income always has to pay their share of taxes on it, but you can split your pension income. Okay.

Speaker 1: 7:57

Now here's another cool thing that you can get if you are over age 65, and you have pension income again, that's pensions or RIFs and a few other niche scenarios that I'm not going into. But if you have eligible pension income after age 65, you get a tax credit of $2,000. Now that doesn't mean that you get $2,000 of pension income for free. It doesn't mean you get $2,000 back. What that means is that for I'll just speak to the federal portion here is that you multiply the $2,000 tax credit amount by the lowest federal tax rate of 15% to get $300. So if you have at least $2,000 of pension income, you will get at least $300 back on your taxes. Pretty cool.

Speaker 1: 8:43

I believe every province also has a provincial pension tax credit as well, but the amounts are very, very different. So, using Ontario again, the amount that you would receive for the provincial tax credit is $87 plus the federal portion of $300, for a total reduction in taxes of $387. In Saskatchewan ours is a little bit more juicy. Sorry, ontario, but we get $105 back in Saskatchewan. Alberta is crazy $169. So again, they're very, very different depending on your province. But it's a matter of tens of dollars, not thousands here. But anyways, this is a cool way to get some of your RSP turned RIF money out at a lower tax rate than you typically would. So I've seen a few situations where people are still working but they convert part of their RSPs to RIFs to take out $2,000 a year because that's a really cheap way to get money out of your RSP. This is very situational, so please consult your plan to see if this actually makes sense for you to do. But the pension tax credit is pretty neat.

Speaker 1: 9:52

Another little wrinkle with the pension tax credit is that if you are someone who is over 65 and you're splitting eligible pension income with your spouse, your spouse will actually get a tax credit as well for the 2000. So this is another income splitting opportunity to get more tax credits for both of you. So pension income splitting is really awesome. It is something that most tax filing software will do automatically. I think they will always ask you. I'm not as up to speed with it with every tax filing software that's out there, but this is one thing that if you're filing your taxes again, if you're over 65 and you have this type of income, you want to make sure that it is done correctly, because the opportunity here is huge for reducing your lifetime tax bill.

Speaker 1: 10:36

Okay, finally, a couple more things to clarify here. So even though most people are going to have CPP income that's Canada pension plan income even though it's in the name pension, it doesn't count as eligible pension income. That can be split in the same way. But here is the nice thing is that if you have a huge discrepancy and CPP between you and your spouse, you can do something called pension sharing. I could probably do a whole episode on this, but pension sharing is a complicated process that functionally allows you to pool your CPP amounts together based on the years that you were together with your spouse, and then you can share those amounts. It gets really convoluted, but largely speaking, there is a process to be able to do it, but it's done at the CPP level, not on your tax return. So if you wanted to share your CPP pension, because there's a huge gap between you and your spouse one's getting 1200, the other one's getting 200. Yeah, it might be something to consider there. You can look online to see what the process is like for sharing your CPP amount.

Speaker 1: 11:45

Old age security that's another thing that people think of as a government pension. No, that one also doesn't count for pension splitting. I'm testing out my sound effects here and I'm really liking it for this. So you know you can't ever split OAS. The second bad thing about CPP and OAS from this episode's perspective is that neither of them count as pension income for the purposes of the pension tax credit. So to be able to get the pension tax credit, the two big sources of income again are going to be that defined benefit pension or RIF income. Rif is the second life of the RSP.

Speaker 1: 12:21

Let me quickly summarize here Having a large amount of income in one person's name is suboptimal from a tax perspective compared to having half of that amount in two people's names here in Canada. So splitting your income is much more tax efficient In your earning years. It's much, much harder to do that. I'm not being sneaky, but there's just in Canada. We don't really have a mechanism to do that during your earning years, but the best way to split income is during your retirement years, after age 65, using the pension income splitting provisions for things like RIFs and defined benefit pensions. Doing this will allow you to share up to 50% of your income with a spouse, even if they're younger than 65. And the reason for that is that you'll pay way less in taxes. Finally, by doing so, you become eligible for the pension tax credit of $2,000. Depending on your province, it'll change how much value this actually is. At the end of the day, it's not huge. It's not going to make the difference between you being able to retire or not, but it's a few hundred bucks and it is worth taking a look at to see if having eligible pension income after age 65 is something that's appropriate for you.

Speaker 1: 13:31

So, anyways, this one's into the weeds a little bit more than some of my other episodes recently, but if you like something like this, let me know. Shoot me an email over at podcast at evanufeldcom. And yeah, this episode came from an idea from someone that submitted a question a few months back and had some questions about income splitting, so I thought I would talk about it here on the podcast. So again, thanks so much for listening and we will catch you on another episode next week. Thanks for listening to this episode of the Canadian Money Roadmap Podcast. Any rates of return or investments discussed are historical or hypothetical and are intended to be used for educational purposes only. You should always consult with your financial, legal and tax advisors before making changes to your financial plan. Evan Newveld is a certified financial planner and registered investment fund advisor. Mutual funds and ETFs are provided by Sterling Mutuals Inc.