Retirement Tax Strategies: Maximizing Your Use of the Pension Tax Credit

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Retirement has arrived.

It is now time to do all of the things you love, from picking up that book you never had time to read to taking a trip down south to soak up some sun.

It would be nice to have a retirement life where money was never an object, however to do many of the things we want and to simply uphold the same lifestyle we had during our working years, money remains a necessity.

Efficient tax planning can go a long way in helping you get the most out of your earnings and savings. The pension tax credit is a nice little present our federal and provincial governments has offered us to maximize our tax savings during retirement.  Using certain tax strategies can help you get more out of your tax credit than you think.

What is the Pension Tax Credit?

This tax credit is available to you once you have reached 55 years of age or older. However, certain exceptions apply if you are younger than 65 years old. For your federal income taxes, the tax credit is equal to the lesser of $2,000 or your pension income. In Ontario, you will also have the ability to claim a tax credit of up to $1,337 on your 2014 provincial income taxes.  These are considered non-refundable tax credits and cannot be carried over to future years. Essentially, assuming your income qualifies as pension income, your first $2,000 earned will be free of federal taxes and your first $1,337 will be free of provincial taxes.

What counts as Eligible Pension Income?

As mentioned previously, some particularities exist when you are younger than 65 years old. Essentially, when you are between the age of 55 and 65, only the following items qualify as pension income:

  • Life Annuity payments from a superannuation or income from a pension plan
  • Or, Annuity income arising from the death of a spouse (or common law partner) under a RRSP, RRIF or DPSP

Once you have reached the age of 65 all of the following income types will qualify as eligible pension income:

  • Life Annuity payments from a superannuation or income from a pension plan (includes income from life income funds (LIFs) and locked-in retirement income funds (LRIFs)).
  • - Annuity income out of a RRSP or a Deferred Profit Sharing Plan (DPSP).
  • Income from a Registered Retirement Income Fund (RRIF).  Note that any portion that’s transferred to an RRSP, another RRIF, or used to purchase an annuity does not qualify for the pension income amount.
  • Regular annuities and income averaging annuity contacts (IAAC).
  •  Income from foreign pensions (income from a US IRA account does not qualify).
  • Or, RRIF payments received as a result of the death of a spouse or common-law partner.

Although after the age of 65 there appears to be a large amount of items that count as “pension income”, a few that are not counted and cannot be countered by the pension tax credit are the CPP, QPP, OAS (or the OAS supplement), death benefits or income coming from a retirement compensation arrangement.

Split Your Income for Added Benefits

One of the most commonly used tax strategies at retirement is income splitting. If one spouse earns significantly more than the other there may be opportunity to significantly reduce your overall tax burden.

The Canadian government allows you to split up to 50% of your pension income with your spouse for tax purposes which in many instances can save you lots of tax dollars! The premise is that due to Canada’s incremental tax brackets, one person earning $70,000 a year will pay much more taxes than two people earning $35,000 each.

Naturally, the splitting of pension income can allow you in certain instances to benefit from added pension tax credits. For example, let’s say one spouse earns a defined benefit pension income of $55,000 per year while his spouse earns no pension income.  The pensioner may choose to split up to 50% of his pension for tax purposes with his spouse. By doing so, the person being transferred the pension will also be able to claim a pension credit on the transferred income. The total fiscal impact will also be lower as the income will be taxed at a lower effective tax rate in the hands of two individuals rather than one. After all taxes have been filed, this couple was able to double the impact of their pension credits as well as maximizing their tax savings by splitting pension income.

At retirement, take advantage of the tax credits made available to you and keep more money in your pocket. You’ve worked hard your whole life and you should enjoy the fruits of your labor.