Senior couples with pension income may now be able to save taxes by splitting their pension income between the two partners.

But the strategy only works if one spouse or partner is in a lower income tax bracket than the other. In that case, up to half the pension income of the higher-income spouse can be allocated to the lower-income spouse, who will then pay taxes on the income at the lower rate.

The attractiveness of the proposal depends very much on how the individual is employed, says Scott McKenzie, regional vice president and general manager, Ontario region, of T.E. Wealth in Toronto. Unless taxpayers have a registered pension plan at work, they have to wait until age 65 to take advantage of income-splitting, he says. This may limit the appeal of the proposal.

But there can be other advantages in cases in which spouses are in different tax brackets. For example, McKenzie suggests, for well-off clients who don’t need the pension income to live on, the pension income can be transferred to the lower-income spouse, who can then invest it. In that case, the investment income is subject to a lower rate of taxation.

Pension income-splitting — first announced on Oct. 31, 2006, as the federal government’s response to the storm over its decision to change the taxation of income trusts — was confirmed in this year’s federal budget and is to be effective beginning with 2007 income tax returns. Spouses will have to make a joint election to split the pension income on a prescribed form when they file their individual income tax returns for the year.

It should be noted the pension income will not actually be paid to the lower-income spouse, so it is not necessary to notify the payer of the pension.

However, the lower-income spouse who takes on the tax liability may lose tax credits based on individual income, such as the age amount and the spouse or common-law partner amount, depending on how much income is transferred, McKenzie says.

Although splitting the pension income could reduce or eliminate the old-age security benefit clawback for the higher-income spouse, amounts transferred have to be calculated carefully so that the lower-income spouse does not become subject to the clawback. (For the 2007 taxation year, individuals with income of more than $63,511 will lose part of their OAS benefits, while the benefit is eliminated completely when the pensioner’s net income reaches $103,101).

Only pension income eligible for the pension income credit can be split — that includes RRSP and RRIF income and income from registered retirement plans, but does not include income from OAS or the Canada Pension Plan.

CPP retirement pensions can already be split by agreement between the spouses or partners when both reach retirement age. Not many people take advantage of this, however, says Loris Giusto, associate partner with KPMG LLP’s enterprise practice in Toronto. When CPP payments are split, each spouse receives a cheque in his or her own name.

Special rules apply when RRSP or RRIF income is being split. In this case, the pensioner must have reached age 65. The age restriction does not apply to splitting of income from an RPP.

McKenzie notes the difference in rules may mean individuals who don’t belong to an RPP or who have group RRSPs through their employer — or individual RRSPs — may have to go on working longer than they had planned if they want to take advantage of pension income-splitting.

Members of an RPP, on the other hand, have more flexibility in timing their retirement decisions if they want to take advantage of the pension income-splitting provisions to reduce their taxes. (See page B15.)

McKenzie notes that the splitting provisions are not of much use to higher-income couples if both spouses are professionals or in the same tax bracket. “It’s going to help the couples in which one spouse worked his or her whole life and got a pension plan in one form or another,” he says, “while the other spouse stayed home with the kids and didn’t go back to work after that.”

Pension income-splitting will only make a difference in situations in which the combined income of the couple is more than $40,000 — the upper limit for the lowest tax bracket.

@page_break@“Tax brackets don’t cover very much income,” McKenzie observes. And he questions to what extent taxes can be saved — especially considering the lower-income spouse may lose the benefit of individual tax credits once the pension income is transferred to her or him.

Although there has been some speculation that the new provisions will sound the death knell for spousal RRSPs, many advi-sors believe spousal plans will continue to be useful. For instance, some note, spousal RRSPs provide a way of equalizing retirement income without having to wait until age 65. And, McKenzie points out, for younger individuals building up spousal RRSP funds for eventual use in the Homebuyers’ Plan, spousal plans are still “a good idea.”

As well, contributions to a spousal RRSP now may be made up to the end of the year in which the beneficiary spouse turns 71. This offers planning possibilities for a contributor who has reached age 71 but still has contribution room and whose spouse is younger. As well, McKenzie notes, unlike the pension income-splitting strategy, ownership of the funds contributed to a spousal RRSP is actually transferred to the beneficiary spouse.

Although pension income-splitting may be a way of equalizing tax liability between spouses in retirement, McKenzie emphasizes that couples should have been planning for this on an ongoing basis. He advises clients to think about what their future retirement income will be early on in life and try continually to work out a balance, equalizing income between spouses.

“A lot of people, for many reasons, have never done that,” he says. For those people, he suggests the pension income-splitting provisions may take care of the situation.

“Usually, it’s making up for people who might not have planned properly when they had the chance,” he observes.

But McKenzie also points out that many people have investment income apart from their pensions. Advisors need to make sure clients plan properly for this income, too.

“While the pension income-splitting provision is obviously a good thing, I don’t think it’s earth-shattering in the end,” he says. IE