Is pension splitting worth it for a retired couple making about $70,000 annually?

Q. I am 71 years old and my spouse Ella is 70. Ella’s total pension income is about $21,000 a year from Canada Pension Plan (CPP), Old Age Security (OAS) and a small private pension, with a non-existent tax bill. My pension income is about $50,000 ($13,000 from CPP, $7,000 from OAS, and $30,000 from an employer pension). In addition, some years I earn up to $20,000 with freelance handyman work. Is pension splitting a good idea for my wife and me? I have not done this in the past. If it is beneficial, can I go back now and pension split on three years’ worth of previous tax returns? And is there any other way we can minimize taxes? Right now (with no pension splitting) I am paying a few hundred dollars in taxes annually.

My other main concern is not that I won’t be able to leave a financial legacy for the family — that ship has sailed — but avoiding leaving any debts to them. Everything I possess goes to my spouse should I be first to go, including 100 per cent of my private pension and my small life insurance policy, which is enough to cover burial costs. In Ontario, does that legacy include my debts? Likewise, should my spouse predecease me, will our children inherit my debts as well as my life insurance when I die? And besides paying down debt that I have and which I likely won’t be able to do fully, is there a better way to deal with this debt? —Thanks, A. Renfrew

FP Answers: Pension splitting is a super idea for every qualifying couple because it reduces household taxes paid and may even reduce or eliminate OAS clawback, leaving more money for you and your partner. Not every couple benefits in the same way; the larger the income difference between partners the larger the benefit.

The two main qualifying pensions you can split are defined benefit plans at any age and income from registered retirement income funds (RRIFs) or life income funds (LIFs) at age 65. You cannot split OAS or registered retirement savings plan (RRSP) withdrawals. You can split some of your CPP but that is a different program for which you must apply.

Yes, you can go back and claim pension splitting not claimed in the past. Either ask your accountant to do it or, go to Canada Revenue Agency (CRA) online into your “My CRA account” and make the change yourself. Your partner has to agree, as they may be paying more in tax even though your combined tax will be less.

Before making the adjustment let’s check to see if the savings are enough to justify your time and expense. The combined taxes on your income come to about $4,800 and with pension splitting you will save $164. When you are earning an extra $20,000 a year as a handyman your total combined taxes are about $10,700 and pension splitting saves about $1,500.

Just for fun, assume you have a good working year and your total income climbs to $100,000. In that case your combined tax is about $21,500, including an OAS clawback of $1,350. Pension splitting saves you $2,400 in tax and avoids OAS clawback.

Beyond pension splitting, the age credit, and the pension credit, it is tough to find additional tax savings when your total income is coming from pensions. However, your unincorporated business expenses as a handyman may provide some deductions.

As an unincorporated business owner, you total your annual business revenues, subtract your expenses, and the difference is added to your other personal income for the year. In other words, although you made $20,000 in your business, after your business expense deductions, which may include past personal expenses such as your phone, you will claim less on your tax return.

Do you know you don’t have to pay your unincorporated business expenses with your business income? You can use this to your advantage and save tax with the cash damming strategy by converting non-deductible interest on your personal loan to tax deductible. This is how you do it. Rather than pay your monthly expenses with business revenue, instead use that revenue to pay down your personal debt. Then borrow the same amount, from a different line of credit, to pay your business expenses, not including your draw, or income.

Now you are paying down your personal debt as fast as you are growing debt to pay business expenses where the interest is tax deductible. The interest tax deduction leaves you more money to pay down your debt faster. Check with your accountant to see if this will work for you.

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If your wife is not a co-borrower and there are no assets left in your estate to pay off debts after you have died, neither your wife nor your children will be responsible for the loan and the loan may never be repaid. Your life insurance and savings in a RRIF and tax-free savings account (TFSA) will pass outside your estate if your wife is the beneficiary or successor owner, and your children are secondary beneficiaries.

Allan Norman, M.Sc., CFP, CIM, provides fee-only certified financial planning services and insurance products through Atlantis Financial Inc. and provides investment advisory services through Aligned Capital Partners Inc., which is regulated by the Canadian Investment Regulatory Organization. He can be reached at [email protected].

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