The March 19 federal budget promised to put more jingle in seniors’ jeans this year, including increasing the spouse credit and raising tax instalment thresholds. These can work with last year’s pension-splitting announcement to reduce overall tax payable for many seniors.
There is a great little calculator on the Department of Finance Website (www.fin.gc.ca) that promises to give you the skinny on how you will fare in the tax payable department in 2007 if you are a senior, depending on your marital status and your income level.
The Finance Website provides a list of pension-splitting assumptions for taxpayers and mentions casually that the provinces and territories may not be on board yet with pension splitting or with the increases to the pension amounts. The federal calculator calculates only the savings on federal tax. We will have to wait to see if the provinces and territories buy in to the pension split and the increased Pension Tax Credit.
CanRev (www.cra-arc.gc.ca) has posted a list of various personal tax credit amounts for easy reference, indexed for 2007, with comparatives for 2006. Note that this list has not been edited for the proposed 2007 budget changes that increase fairness for single earner or sole earner families, more on that later.
How do credits work?
If you add up your 2007 basic personal amount of $8,929, your age amount of $5,177, and your new $2,000 pension mount, the total is $16,106. Essentially a senior could earn $14,000 before paying one dime of tax. Seniors could earn another $2,000 of pension income and not pay tax on that either. Add in other credits for supporting other people and the income earned before paying any tax at all could be even more.
If you earn anywhere up to $37,000, your tax on taxable income is about 21% combined federal and provincial tax rate on the income over and above your personal tax credits. In 2006, if one spouse earned about $40,000 and the other earned $10,000, you would have paid about $5,900, or about 11% of your income out for tax. If you are able to split your pension, and both spouses claim the $2,000 credit, your tax bill could be significantly less — by about $1,400.
What is interesting is that when you split the CPP equally after splitting the other pension of $25,000 between the spouses, the provincial tax payable goes up by about $80.
Creating a pension
Just because you do not have a company pension does not mean you do not have a pension or that you can’t create a pension if you are over 65 years of age.
Your RRSPs converted to RRIFs become pension income reportable on Line 115 on your tax return. Line 115 is the line that triggers the $2,000 credit to appear on the tax credit claim on Line 314.
RRSP withdrawals do not appear on Line 115; they appear on Line 129, and the pension credit is not triggered by Line 129 income.
On death, the lump sum from your RRSP or RRIF is recorded on Line 130, not Line115.
Note that you can convert your RRSP to an RRIF at age 65 (earlier if you are widowed) and that you could choose to convert some of your RRSPs to RRIFs in order to utilize the $2,000 credit. Why would you do this? Because the credit does not accumulate and carry forward — in other words, use it or lose it.
For more information about pensions, RRSPs, and RRIFs, see CanRev’s Guide T4040 — RRSPs and Other Registered PlansFor Retirement, available on the CanRev Website. See also Guide P119 — When you Retire, for more useful information on retirement planning.
I discovered last year that if you have not withdrawn from your RRIF in the year you die, you do not qualify for the pension credit in that year. This prompted me to recommend to at least one client they withdraw at least $2,000 from their RRIF early in the year on January 1 each year to ensure that if they die during year, the door is left open for the estate to claim the pension credit. The $400 in tax savings on your "final return" might be enough to pay for a better urn or flowers at your grave.
You could always split your CPP with your spouse and often people do split both ways in order to level out their income and to keep both incomes between the next tax thresholds to pay the least amount of combined tax. As an "economic unit," your household plans to minimize tax can have an even more significant effect than in the past with the new pension splitting opportunity.
Do you need an RRSP?
If you do not have at least $100,000 in your RRSP, it may be that having an RRSP is not in your best interest. You would have to work out whether or not it is to your advantage to have an RRSP or whether you are better of paying down debt and purchasing a roof over your head with the remainder after paying tax.
Why would I say this? If you have no other income, and your money is sunk into your principal residence, which is after all the last and only truly tax-free haven left, the government tops up your CPP and OAS with GIS. If you live in an apartment and withdraw your money from your RRIF to generate income, your GIS is reduced $0.50 per dollar of RRIF income. If your income is marginal anyway, putting a roof over your head may work out to be a better option than having the money socked away.
If you have other pensions or more than $100,000 in your RRSPs already, your income will be more than that allowed for collecting GIS anyway.
Now what about spousal RRSPs? Spousal RRSPs convert to RRIFs and become pension income as well. There are still advantages to contributing to spousal RRSPs. For example, a young couple may decide to contribute so that while one spouse takes time away from work, they
can draw on their RRSP to supplement the family income beyond the year for maternity leave, for example. As long as no contributions were made to any spousal plans in the past three years, the income is taxed in the hands of the lower-income spouse. Another option is to use the RRSP to defer tax in order to save for a down payment for a home under the Home Buyer’s Plan (note that the Home Buyer’s Plan can also assist with purchasing a home for a related person with a disability).
Another reason to crack open the spousal RRSP might be to fund a large medical expense, for example, a wheelchair, a van with a lift, or an expensive operation.Waiting until the three year cutoff has elapsed can allow for the withdrawn RRSP income to be offset in the year by the medical or disability support expense claim.
Check out Guide RC4064, Medical and Disability-Related Information, for definitions of disability and lists of over 123 medical expenses. This could be a way to fund a seemingly impossible purchase without going into more debt. You have to play with the numbers a bit, but it can work.
The March 19 federal budget proposed to level the playing field for single family earners or families with only one parent. Under the title is "Fairness for Single Earner Families," the proposal would provide a credit for a spouse or an equivalent-to-spouse that is the same as the basic personal amount of $8,929 (in 2007).
Just in case you were wondering, there are the combined tax rates in rounded terms (of course, they will vary by province and territory):
For income below $37,000, 21.5%.
For income between $37,000 and $74,000, 31%.
For income between $74,000 and $120,000, 38% and
For income over $120,000, the combined rate is 44%.
More detailed combined federal/provincial tax brackets and thresholds are available at the tax Websites of most of the major accounting firms, including Grant Thornton, Deloitte & Touche, KPMG, Ernst & Young, and PriceWaterhouseCoopers. These useful Websites provide you with the exact thresholds and rates for each province and territory. This is just a broad generalization for purposes of this discussion.
The tax credits generally reduce the tax payable at a rate of 21.5% for each dollar of credit. Personal credits for yourself, and credits that are transferred to you, are all multiplied by 21.5% to reduce your total tax payable.
Connecting the dots …
Making a connection between your reduced tax payable and when you have to pay your tax is important for seniors in both 2007 and 2008.
Say that your income is $41,000 and your spouse’s is $11,000. Your combined pension income is $52,000. You can now split the income so that up to half of the higher income spouse’s income that qualifies for the pension income credit may be transferred to the lower income spouse. In this case, then, each spouse reports about $26,000. Tax payable will be no more than $3,000 each. Because the threshold at which you will be required to pay tax instalments has been increased to $3,000 from $2,000, neither spouse will be required to remit quarterly installments as of 2008.
If you don’t make this connection between the pension-splitting opportunity and your tax payable you’ll end up paying RevCan too much. So it’s definitely in your best interests to do some tax planning now to calculate the best pension splitting arrangement for the lowest combined tax payable.
Note, too, that the instalment notices from CanRev will not reflect the adjustment for any pension splitting you do, because it will not be able to ascertain whether or not you plan to split your pension or what the effect will be if you do. Keep an eye on the CanRev Website for more information about paying by instalments. In the meantime, see your trusty tax adviser to work out your best pension-splitting strategy.