SPLITTING PENSIONS CAN BE a useful way for retired couples to reduce their taxes. But retirees who are less than 65 years old are being treated differently under Canada’s pension-splitting rules, depending on the type of pensions that they have. In essence, retirees with pensions from employment enjoy greater breaks than those who use a registered retirement income fund (RRIF), a life income fund (LIF) or annuity payments from an RRSP.
The unfairness arises because retirees with a registered pension plan (RPP) from employment can split their pensions with a spouse at any age. But those using the other types of registered savings plans must wait until they are 65 years old. As a result, this latter group faces three forms of discrimination: age, plan type and income taxation.
The pension income-splitting rules under the Income Tax Act, which became effective in 2007, permit retirees aged 65 and over to split up to 50% of their income from an RPP, a LIF or a RRIF with their spouse – creating a level playing field for all retirees in that age bracket.
Typically, income-splitting benefits couples with significant disparities in their incomes. The spouse with the larger income allocates up to 50% of his or her pension income to the lower-income spouse and receives a tax deduction for the amount allocated. The lower-income spouse pays income taxes on the amount allocated. The objective of the income split is to reduce total income taxes payable by the couple by taking advantage of their different tax brackets.
The income-splitting restriction placed on retirees under 65 who get their pension incomes from a RRIF or a LIF is unfair, says Heather Holjevac, a certified financial planner with TriDelta Financial Partners Inc. in Oakville, Ont. She argues that individuals with defined-benefit RPPs “do not have to do any planning; their pensions are pre-defined. Whereas those who depend on income from their RRIF, RRSP or LIF must plan on their own.” Yet, she adds, RPP beneficiaries “end up winners” when it comes to income-splitting before age 65.
CONTROL IS CRITICAL
Dave Ablett, director of tax and estate planning with Winnipeg-based Investors Group Inc., suggests that the federal government had wanted to provide more options for those people with RPP income because those retirees cannot control the timing of pension payments once they have retired. On the other hand, retirees who have RRIFs, RRSPs and LIFs have greater control over the timing of both withdrawals and taxes payable. Ablett does not take a stance on the issue but suggests, “Some individuals believe [the rules] are discriminatory.”
Yves Chartrand, an economist with the Centre québécois de formation en fiscalité in Montreal, however, questions whether individuals who are receiving pension income from an RPP are always what he calls “real retirees.” He has reviewed the tax returns of 622 Quebec families who had benefited from the splitting of pension income before age 65 in 2010 and found that 57%, or 354 families, earned an average working income of $42,154 by continuing to work after they had retired.
Not only are these retired individuals continuing to work, they enjoy significant tax savings by splitting their pension incomes. “In 2009, Ottawa provided $3.6 billion in tax deductions to taxpayers under age 65 who benefited from pension income-splitting. This rule doesn’t make any sense,” says Chartrand, who adds that he has lobbied the federal Department of Finance on at least three occasions “to put an end to this injustice” – to no avail.
When the income-splitting rules were first proposed in 2006, the Investment Funds Institute of Canada (IFIC) had lobbied the minister of finance for an amendment to include all Canadian retirees, regardless of their investment vehicle, in the under-65 rule. A January 2007 memo from IFIC that supports Chartrand’s contention about “working retirees,” had suggested that the rules would “promote both age and plan type discrimination”: “[O] ne could easily envisage a situation where someone in a defined-benefit RPP decides to take early retirement at age 55 for the sole purpose of splitting his or her pension income with a non-working spouse and then immediately recommences employment with a new employer.”
In the meantime, retirees without RPPs have only one option. Both Holjevac and Ablett agree that spousal RRSPs can be used to facilitate income-splitting for the benefit of non-RPP retirees who have yet to reach age 65.
However, Holjevac says, “A lot of planning has to be done [for this] to be effective – something that most individuals do not take the time to do. A lot of individuals wait until they are close to retirement before they start thinking about things such as spousal RRSPs for income-splitting. But, by then, it is generally too late to maximize the potential benefit.”
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