Your Guide to Income Splitting In Canada for 2024
One of the difficulties that many Canadians face as they age is the fact that pension income can increase their taxes paid. This can be especially frustrating in situations when you might have a higher income due to your pension, investments and possibly a higher income job, but your spouse has a much lower income and a lower tax rate.
Beginning in 2007, the Canada Revenue Agency introduced a new way of reporting pension income: You can actually split it so that some of the income goes to your spouse in a lower tax rate, with the ultimate goal being to lower your household income tax.
How Does Income Splitting Work?
Simply put, income splitting involves the transfer of income from the higher-earning spouse to the lower one. The result is a smaller tax bill, because more income is being taxed in a lower bracket, thanks to Canada’s progressive tax bracket system. There are several limitations to income splitting, but the government does allow it in certain circumstances.
Am I Eligible for Pension Income Splitting?
The Canadian government has very clear guidelines around pension income splitting. Below is a list of pension income that is and isn’t eligible, however, I highly recommend that you check an accountant as well as the CRA website prior to filing your taxes. Keep in mind that age can be a factor as well, as some of the eligibility depends on whether or not you are 65 or over.
Eligible Pension Income Splitting
Here is a list of pension income sources that are generally accepted for income splitting purposes. Note that CPP and OAS income is not included. More on that further down.
- Annuity payments (the taxable portion) from a pension or superannuation plan.
If a spouse or common-law partner dies, or if the transferring spouse turns 65 by the end of the calendar year, then the following income is also eligible to be split.
- Annuity and RRIF income, Life Income Fund (LIF) payments
- RRSP annuity payments
- Qualifying amounts from a retirement compensation agreement
Ineligible Pension Income Splitting
The following income is ineligible for pension splitting. In the case of the Canada Pension Plan, there is something called CPP splitting that spouses can apply for, but that is different than income splitting. I’ve provided more detail on CPP splitting below.
- OAS payments
- CPP, QPP pension plan payments
- Income from an IRA (US)
- Any foreign pension that is not subject to income tax in Canada due to a tax treaty
Pension Income Splitting – Other Conditions
In addition to knowing which types of pension income are eligible, you and your spouse or common-law partner must meet all of the following conditions to qualify:
- Marital breakdown – You were not living separate and apart due to a breakdown of your relationship at the end of the tax year, or for a period of 90 days or more that began in the tax year, you are ineligible.
- Canadian residency – You were both Canadian residents on December 31st of the tax year.
- Pension Income – You received pension income that qualifies for the pension income amount, or, if you are 65 or over, you were paid qualifying amounts from an RCA (retirement compensation agreement).
Many people confuse Canada Pension Plan (CPP) splitting with pension income splitting, but while the two can achieve a similar result (lower taxes), they are not the same thing. If you and your spouse or common-law partner both collect CPP, and one of you is in a higher tax bracket than the other, you can apply to the CRA to have your CPP payments equalized. So, instead of one spouse receiving, let’s say $700/month and the other $300, the CRA will pay each spouse $500/month. To qualify, both spouses must be 60 or over and already be collecting CPP.
If you are both in the same tax bracket prior to the CPP split, there really is no benefit to this arrangement, because you won’t realize any tax savings. It’s when the CPP split shifts the higher-earning spouse into a lower bracket where the savings occur.
How Do I Report Pension Income Splitting?
In order to take advantage of this provision, both you (transferor in the higher tax bracket) and your spouse (the lower-income transferee) need to file tax returns. Together, you fill out Form T1032, Joint Election to Split Pension Income. Both of you need to sign the form in order for it to be valid.
The amount that is split appears on Line E. Each of you needs to file a tax return. However, the amount from Line E will go on different lines of your T1 forms. The pensioner reports the amount on line 210, and the pension transferee reports the amount line 116.
Once this is done, the income for each of you changes. If your spouse’s income is much lower than yours, there is a good chance that adding more won’t harm your situation. In fact, he or she may still be in a lower bracket.
If you plan it properly, you might even drop to a lower tax bracket as a result of the income split. This will reduce your income so that you don’t pay as much in taxes.
What Is the Benefit of Income Splitting?
It’s pretty clear that the benefit of being able to income split with your spouse comes down to paying less tax. And that’s not a small thing. Depending on where you live in Canada, if you happen to be a high-income earner your marginal tax rate could be in excess of 50%!
If you or your spouse are drawing significantly more retirement income than your partner, you should be looking into whether or not you qualify to split income with them. Of course, it goes without saying that before including income splitting in your tax return, make sure you seek advice from a tax professional and visit the CRA website for more details.