You pay taxes even after retirement. Hence, tax planning is a part and parcel of your retirement planning, as most pension income is taxable. Speaking of tax planning, the Canada Revenue Agency (CRA) offers retirees several tax benefits to ensure they have sufficient income to live a comfortable life. One such tax benefit is pension splitting, which allows you to split 50% of your pension income with your lower-income spouse or common-law partner, reducing your taxable income.
Suppose your eligible pension income is $50,000 and your income from other sources is $30,000. You can split up to $25,000 of your pension income with your spouse and reduce your taxable income to $55,000. Assuming your spouse has a low income, both will have income under the 15% federal tax bracket. In this process, you don’t actually give your income to your spouse, but only fill in the amount you want to split in the form T10321 Joint Election to Split Pension Income when you file your tax returns.
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Why is the CRA cracking down on pension splitting?
While pension splitting is a lucrative tax benefit, it is also on the CRA’s list, as many people misuse such benefits to avoid taxes. Hence, the CRA has in place a long list of rules to be eligible for this benefit.
The pension splitting benefit is for Canadian residents
- Who are married or have a common-law partner;
- Who are living together; and
- For couples in which one person has a lower income.
If the following basic rules are breached, the CRA will come looking for you:
- If you are splitting a pension with your partner, who you have divorced or are separated from.
- You are not living with your spouse.
- There are discrepancies in reported income levels between spouses.
- Neither partner has signed Form T1032.
Pension income is eligible for a split
The CRA introduced the pension-splitting benefit to encourage Canadians to save for retirement beyond the mandatory Canada Pension Plan (CPP). The CRA can crack down on your pension splitting request if you split
- Government pension: CPP and Old Age Security (OAS); and
- Registered Retirement Savings Plan (RRSP) withdrawals.
The pension income splitting can be done for
- Annuity payments from a Registered Retirement Savings Plan and a Deferred Profit-Sharing Plan; and
- Income from Registered Pension Plans and Registered Retirement Income Funds.
A tax-free income that doesn’t need income splitting to reduce tax
Instead of cracking your brains around the complex tax benefits and still being at risk of a CRA crackdown, let’s keep it simple. Your Tax-Free Savings Account (TFSA) allows you to withdraw any amount anytime without having to report it under taxable income. Building a portfolio of income stocks can pay you a TFSA pension, taking care of both retirement and tax planning.
Canadian Natural Resources (TSX: CNQ) is a good stock to accumulate for your TFSA pension. For starters, it has been growing dividends for the last 23 years by an average annual rate of 23%. Behind this consistent performance is the cost advantage from its low-maintenance, high-reserves oil sands project. The company includes the dividend amount in its production cost, which is mid-$40s per barrel. It keeps growing production and repurchasing shares, which helps it increase dividends.
You can keep adding these shares and even use the dividend from CNQ to buy other income stocks, such as Telus Corporation, which also offers a dividend-reinvestment plan.
