Two retirees can share a kitchen, a car and an impressive collection of reusable grocery bags while still receiving very different tax bills. If most pension income lands on one return, the household may be paying more than it needs to.
Pension income splitting can help change that. The opportunity is especially useful when one spouse has a substantial workplace pension or retirement-account withdrawals and the other has much less taxable income.
The catch is timing. You generally make the election when filing your returns, but some income needs to exist by December 31. Waiting until April to discover that distinction is an unnecessarily expensive way to learn it. So, how do couples fix that?
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Create the right income
The Canada Revenue Agency allows eligible couples to allocate up to 50% of qualifying pension income to the other spouse or common-law partner for tax purposes. That doesn’t require physically handing over half the pension cheque. Both partners make the election using Form T1032, allocating the associated withholding tax proportionately.
For someone aged 65 or older by year-end, qualifying registered retirement income fund withdrawals generally count. Ordinary registered retirement savings plan withdrawals generally don’t. Workplace pension income can qualify before 65, subject to the rules.
Canada Pension Plan payments and Old Age Security aren’t eligible for this particular election. CPP pension sharing is a separate arrangement, so the benefits shouldn’t all be tossed into the same tax basket.
If you’re 65 and relying on Registered Retirement Savings Plan (RRSP) withdrawals, converting an appropriate portion to a Registered Retirement Income Fund (RRIF) before year-end may create eligible income. The withdrawal must actually occur during the year, so leave the institution time to process it.
What could you keep
Suppose a couple allocates $10,000 of eligible pension income from a spouse whose relevant marginal tax rate is 30% to one whose rate is 20%. Here’s what that tax avoidance could look like.
| Illustrative tax calculation | Amount |
|---|---|
| Tax avoided at 30% | $3,000 |
| Tax added at 20% | $2,000 |
| Household tax reduction | $1,000 |
Actual savings depend on province, brackets, credits and benefits. Pension splitting can also affect individual-income calculations such as the OAS recovery tax, while leaving combined household income unchanged.
The best split isn’t automatically 50%. Moving too much income can reduce the receiving spouse’s credits or create other costs. Comparing both completed returns reveals the household result. But from there, investors could take those savings and turn them into more retirement cash.
Let the savings stay yours
Keeping an extra $1,000 means less money has to come out of the portfolio. That gives long-term holdings more room to compound, including businesses such as Sun Life Financial (TSX: SLF).
Sun Life earns from insurance, workplace benefits and investment management across several markets. Its Asian operations provide a growth opportunity beyond Canada’s mature insurance market.
Second-quarter underlying earnings reached $2.02 a share, up 13%. Its $0.96 quarterly dividend used about 48% of that amount, leaving an earnings cushion for reinvestment and shareholder payments. At a recent share price of $111, the annualized $3.84 dividend yields approximately 3.5%. Here’s what that $10,000 could bring in.
| COMPANY | RECENT PRICE | NUMBER OF SHARES | ANNUAL DIVIDEND | ANNUAL TOTAL PAYOUT | FREQUENCY | TOTAL INVESTMENT |
|---|---|---|---|---|---|---|
| SLF | $111.21 | 89 | $3.84 | $341.76 | Quarterly | $9,897.69 |
That income helps explain why dividend investing can complement tax planning. The tax savings don’t require Sun Life to rally, while the investment still needs business growth.
Give the stock time
I’d hold Sun Life for diversified insurance exposure and dividend growth, with claims costs and market-sensitive investment fees as the main risks. Its yield is useful, though not so high that valuation can be ignored.
Money needed for next year’s withdrawals should remain accessible. A Tax-Free Savings Account (TFSA) can shelter eligible future income if you have contribution room, but RRIF withdrawals remain taxable when transferred there.
Bottom line
Check the pension-income setup before December 31. Keeping more of the money your portfolio already earns can give retirement savings a longer working life, without asking you to find the next winning stock.
