Wealth Strategies: Income Splitting Strategies in Retiremnt

 

Income splitting strategies are a vital tool for Canadian retirees aiming to reduce household taxes and maximize retirement income. They work by shifting income from the higher-earning spouse to the lower-earning spouse, allowing both partners to benefit from lower tax brackets.

Pension Income Splitting: The Core Strategy

Retired Canadians can allocate up to 50% of their eligible pension income to their spouse or common-law partner for tax purposes. Eligible sources include:

• Registered Pension Plan (RPP) payments, at any age
• Registered Retirement Income Fund (RRIF) and Life Income Fund (LIF) withdrawals, once the transferring spouse reaches age 65
• Certain annuity-type payments from pension plans
• CPP/QPP benefits have their own pension sharing process

However, RRSP withdrawals are not eligible unless converted to a RRIF after age 65, and Old Age Security (OAS) cannot be split. To split income, couples must file CRA Form T1032 annually, deciding each tax year how much income to allocate.

Spousal RRSPs: Building Flexibility Before Retirement

A practical long-term strategy, spousal RRSPs involve contributing to a lower-income spouse’s RRSP during working years. This allows future withdrawals to be taxed at the lower rate of the recipient, not the contributor, which achieves the same effect as income splitting—especially for those retiring before age 65 or without workplace pensions.

Other Notable Income Splitting Strategies (Before and During Retirement)  

• Having the higher-earning spouse pay all household expenses, freeing up the lower-income spouse to invest in non-registered accounts and claim the taxable income.
• Gifting funds from the higher-earning spouse to the other to contribute to their own TFSA, helping shelter investment growth from taxation, if they have available contribution room.
• If one spouse has unrealized capital losses and no capital gains, those losses can be transferred to the other spouse to offset their capital gains. This is done by having the first spouse sell the securities and the second spouse repurchase them within 30 days.
• Spousal loans allow a higher-income spouse to lend funds to a lower-income spouse at the CRA's prescribed interest rate, enabling the lower-income spouse to invest and pay tax on investment income at a lower rate, provided annual interest is paid on time to avoid attribution rules. It is important to note that this strategy is more effective in a low-interest rate environment.

 

Why It Matters

By distributing retirement income more evenly, couples can lower their household’s overall tax bill, preserve more assets, and potentially access valuable credits such as the Pension Income Tax Credit, available for up to $2,000 in pension income annually.

Retirees should review these strategies regularly and consult with financial professionals to ensure compliance, optimize tax savings, and adapt to changing retirement needs in Canada.

Sources: Canada.ca, BDO Canada, Mackenzie Investments 

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