Given the magnitude of Ottawa’s announced deficit and the debt that will have to be paid off, we will soon find ourselves faced with heartbreaking choices.
So every time I come across something that looks like a tax advantage, the question automatically arises: “Is this case likely to go by the wayside?” “
So I wondered about pension income splitting.
The ABCs of fractionation
I touched on the subject recently, the reaction of readers prompted me to come back to it. The principle is quite simple. Basically, taxpayers who receive pension income have the option of transferring up to 50% of it to their spouse in order to reduce the couple’s overall tax bill.
The operation is only profitable if the spouses occupy different tax brackets, so that a significant income gap separates the retirees.
By transferring part of their income to the spouse who earns less money, the richer person ensures that the amounts shifted will be taxed at a lower rate. Splitting does not involve an actual transfer of money, it is an accounting mechanism applied when filing income tax returns.
Note that this possibility does not go back to the dawn of time, it was introduced in 2007.
I spare you the fine details, the broad outlines are enough to understand the stakes.
Only pension income can be transferred to the spouse. These include, among others, the annuity of a supplemental pension plan, withdrawals from a registered retirement income fund (RRIF) or a life income fund (LIF), the life annuity acquired by the ‘intermediary of an RRSP (registered retirement savings plan) or a locked-in retirement account (LIRA).
Benefits from the Quebec Pension Plan and Old Age Security are excluded.
In Quebec, you cannot use fractionation before age 65. Also at the federal level, with the notable exception of income from a defined benefit pension plan, half of which can be transferred at any age to a spouse.
The resulting tax savings can be substantial. To get an idea of the impact of income splitting, I used the disposable income calculator on the Quebec Ministry of Finance website.
Take, for example, a retired couple whose combined income is $ 85,000 and suppose it is broken down like this: $ 65,000 / $ 20,000. According to the calculator, the disposable income of this household would be $ 78,102.
If the income is distributed more evenly using the splitting mechanism, say $ 45,000 / $ 40,000, disposable income jumps to $ 80,050, a tax saving of almost $ 2,000.
This tax advantage only benefits some retirees, and not the poorest. In 2017, it cost the federal government something between $ 1.2 billion and $ 1.4 billion. As the number of retirees increases, the tax receipts from which Ottawa is deprived will also swell.
The Chair in Taxation and Public Finance at the University of Sherbrooke looked into the issue last year, before public finances were hit hard by the pandemic.
How could that be cut?
The researchers explored various scenarios, without completely eliminating the possibility of income splitting. The simplest and most profitable measure would be for Ottawa to imitate Quebec and not tolerate any exceptions to the age criterion.
The federal government would thus seek more than $ 400 million per year from beneficiaries of a pension plan with benefits under 65 years of age.
Does that make you want to cry?