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tax matters

Kids these days aren't the only ones texting each other. Many seniors are tech-savvy today, too. Seniors even have their own texting lingo. For example, BFF means "best friend fainted." BYOT means "bring your own teeth," LMDO means "laughing my dentures out" and SMPI means "splitting my pension income." It's this last concept that I want to talk about today.

The concept

In 2007, our government introduced the opportunity for older Canadians to shift certain pension income from one spouse to the other – known as pension income splitting, and the idea could save you tax dollars.

The rules allow a pensioner to transfer up to one half of his or her eligible pension income to a spouse or common-law partner. You can accomplish this by filing a joint election using Form T1032, the Joint Election To Split Pension Income, by the deadline for your tax return. (By the way, it may be possible to file a late or amended election, or to revoke a previously filed election; speak to a tax pro for more details).

To do this, it's important that you and your spouse or common-law partner were not – because of a breakdown in your relationship – living separate and apart at the end of the year and for a period of at least 90 days that began during the year.

On top of this, you both had to be residents of Canada on Dec. 31 of the year for which you want to make a transfer, and you had to have received eligible pension income. If you're under age 65, this income includes payments from a registered pension plan, or certain amounts received as a result of a partner's death. If you're over 65, you can add payments from a registered retirement income fund or annuity payments from a registered retirement savings plan. Sorry, but Old Age Security (OAS) and Canada Pension Plan (CPP) benefits won't qualify.

The problem

Conventional wisdom suggests that a higher-income spouse should transfer part of his or her eligible pension income to a lower-income spouse or common-law partner until their incomes are equal. Not so fast. While it's true that splitting pension income can allow those transferred dollars to be taxed at your spouse's lower marginal tax rate, and will create the opportunity for an additional pension income credit, there are potential costs, too.

Specifically, transferring pension income could cause you or your spouse to give up all of some of the following benefits and credits: OAS benefits (these benefits might have to be repaid as income increases), the age amount, spousal amount, the medical expense tax credit (you can only claim expenses that are in excess of $2,171 or 3 per cent of net income, whichever is less), and any other credits that are income-tested – which means they're affected by your level of income.

The example

Let's consider John and Jane, a married couple. Suppose that John has eligible pension income of $50,000, OAS benefits of $6,677 and other income of $20,000, for a total income of $76,677. As for Jane, her total income is less, at $46,677, made up of OAS benefits of $6,677 and other income (not pensions) of $40,000.

You might assume that transferring some of John's pension income to Jane to make their incomes equal would be optimal for them. That is, if John were to transfer $15,000 of his pension income to Jane, they would both have incomes of $61,677. Would this save them tax dollars? Yes, it would result in exactly equal tax liabilities and would save them $882 over all.

Yet, this isn't the optimal scenario. As curious as it may seem, their taxes are minimized when John transfers just $5,500 to Jane. In this case, they will save $917 as a couple. Now, the difference between $917 and $882 in tax savings may not be significant, but the actual dollars saved can be very different depending on the level of income of each spouse and the disparity between incomes.

The moral

The total tax savings from transferring income from one spouse to the next will depend on how the transfer affects your other income-tested amounts – some of which I mentioned above. The moral of the story is this: There is good news here. You can save taxes by transferring pension income. The bad news is that doing the math in your head, or on the back of a napkin, is nearly impossible. To determine the optimal amount of pension income to transfer to your spouse you need to use tax software, or have a professional with tax software do the math for you.

Tim Cestnick is managing director of Advanced Wealth Planning, Scotiabank Global Wealth Management, and founder of WaterStreet Family Offices.