Pension income-splitting, which took effect in the 2007 tax year, may mean savings of hundreds or even thousands of dollars for your clients. It may also protect them against clawbacks of their old-age security benefits.

In fact, the Department of Finance claims on its Web site that the new rules could result in more than $1 billion in tax relief for Canadians every year.

There are techniques you can use to determine whether your clients will benefit from pension income-splitting, and how they can get the most from the strategy.

First, make sure clients understand that splitting pension income is not the same as splitting income from the Canada Pension Plan/Quebec Pension Plan, says Jeff Greenberg, vice president of financial advisory support, wealth management services, with Royal Bank of Canada in Toronto.

“CPP/QPP splitting allows a spouse who spent years in the workforce to share up to half of his or her CPP or QPP entitlement with a spouse who worked fewer years,” he says. “It’s a reallocation of actual money. The second spouse gets a cheque from the government.”

Pension income-splitting, on the other hand, allows a client who receives eligible pension income to shift up to 50% of it to a spouse for tax purposes. “No money actually changes hands,” Greenberg says. “The pension cheques continue going to the first spouse.”

Pension income that qualifies for the $2,000 federal pension income credit qualifies for pension income-splitting. For Canadians under age 65, eligible pension income includes payments from company pension plans and certain pension income received on the death of a previous spouse.

For those aged 65 and over, income from an RRSP annuity, a RRIF, a locked-in RRIF and a deferred profit-sharing plan annuity are eligible to be split.

Income that does not qualify includes CPP/QPP and OAS payments, the guaranteed income supplement, RRSP withdrawals and income from retirement compensation arrangements.

REDUCE COUPLE’S TAXES

Couples can be married or in common-law arrangements, including same-sex partners. They must be living together and residents of Canada.

“Allocating income to a spouse with a lower tax rate may reduce a couple’s taxes,” says Chris Dyer, regional sales manager with Bank of Montreal in Winnipeg. “It could also protect the higher-income spouse from a clawback to OAS payments, which in 2008 kicks in when income reaches $64,718. After that, the benefit is reduced by 15¢ for every $1 of income.

“But it may not be useful,” he adds, “for partners in the same tax bracket.”

The challenge lies in determining whether to split pension income and, for couples who opt for the strategy, just how much income to allocate, says Murray Pituley, director of tax and estate planning with Investors Group Inc. in Regina. “If I have $60,000 in eligible income and allocate half to my wife, her income goes up by $30,000, which may erode some of her benefits and credits,” he says. “Some provinces have drug plans for seniors for which your client may be ineligible over a certain income level.”

The first thing Pituley looks at when he’s considering pension income-splitting for clients is the tax bracket — not the income — of each spouse. “Then I check for things that allocating pension income could affect.”

Certain tax credits can be transferred from one spouse to another. Some that may apply to your older clients include:

> The Age Credit. The maximum amount is available only to seniors 65 and older who have net income of less than $33,524. The credit is fully phased out when net income reaches $66,697 for 2008.

> The Education Tax Credit, which can be claimed by clients who return to university.

> The Pension Income Credit, which allows a client to claim the first $2,000 of annual pension income tax-free.

> The Disability Credit. A client whose medical condition qualifies him or her for this credit can transfer it to a spouse who is not disabled.

Assessing whether the reduction in taxes from pension income-splitting will outweigh other benefits that a spouse can claim is a balancing act. “You’ll need to review your client’s situation every year,” Pituley says. “Circumstances and tax brackets may have changed.”

While allocating income to a spouse may erode his or her OAS payments, Pituley says, “The clawback may be a small price to pay when you look at the couple’s overall tax savings.”

@page_break@DOUBLE UP ON CREDITS

In some cases, pension income-splitting may allow a couple to double up on the pension income credit. “Say I’m 70 and getting income from my RRIF, and my wife is 68 and her income comes from CPP and OAS payments and unregistered investments — meaning she isn’t eligible for the pension income credit,” Pituley says. “By allocating some of my RRIF income to her, she may now be eligible for the $2,000 pension income credit.”

One client with whom Greenberg worked in the 2007 tax season was facing a tax liability, while the partner was entitled to a refund. “By transferring pension income,” he says, “we were able to reduce the tax liability, albeit decreasing the other spouse’s refund. But the cheque the client had write to the government was smaller.”

Advisors need to be aware of pension income-splitting as a financial planning tool, adds Greenberg. He was able to make adjustments using this strategy for every couple with whom he worked during this past tax season.

“But the nitty-gritty may be a job for tax accountants,” he says. “There are so many things going on simultaneously that it’s necessary to use software that allows you to try different combinations.”

What Greenberg particularly likes about the strategy is that it’s a year-by-year process: “One year it may work to your client’s advantage; another year, you might not use it.”

And because pension income-splitting is done on an annual basis and applies only to couples who were living together at the end of the tax year, it is not applicable to spouses who separate.

Greenberg says pension income-splitting shouldn’t eliminate spousal RRSPs from a financial planner’s toolbox. Spousal RRSPs are often used by younger couples who may not receive pension income. The higher-earning spouse contributes to a lower-income spouse’s RRSP, thereby reducing the couple’s overall tax hit and building the second spouse’s retirement assets. (See “An effective means,” page B12.)

“And a client may be receiving pension income, but as long as he or she is still working and earning income, that client should be contributing to an RRSP and taking advantage of the income-splitting possibilities of spousal plans,” Greenberg adds. “Good financial planning requires as many tax-
reduction strategies as possible.” IE