Clients want to know: How can I keep more of my retirement income?

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1 Clients want to know: How can I keep more of my retirement income? After reading this, you should understand: The strategies that enable pensioners to pay less tax Regardless of the source of retirement income, it is subject to taxation. The objective for most people living on fixed incomes is to reduce tax, so that more income is left over for retirement living purposes. Taxation of Retirement Income Personal, Non-registered Savings A benefit of non-registered savings is that investment income earned as dividends and capital gains will be taxed at their preferred rates. Registered Savings Plans All income from a Registered Retirement Savings Plan (RRSP), whether a selfdirected or managed plan, and a Registered Retirement Income Fund, including all locked-in plans, is taxed as income. When it comes to LIFs, RRIFs, and RRSPs, which of the following is incorrect? A All investment income inside these registered plans is taxed as received; original invested capital is not taxed. B There is no distinction between original capital and investment earnings in a LIF. C Investment earnings are not taxed inside an RRSP. D Withdrawals from these plans are subject to tax at the annuitant s marginal tax rate there is no distinction between investment earnings and original vested capital. Registered Pension Plans Employer contributions are tax-deductible for the employer. Employee contributions are tax-deductible to the employee. Employees are taxed on the pension income when it is received (usually following retirement), and up to $2,000 per year may be exempted by the pension income credit after age 65. Copyright 2011 Oliver Publishing Inc. All rights reserved. 365

2 LLQP Deferred Profit-sharing Plans Assets accumulate in a DPSP tax-free, and cannot be transferred, assigned, or used as loan collateral. All benefits received by employees are taxed as ordinary income, except for accumulated capital gains on employer shares transferred to the plan. If common shares in a DPSP are transferred to the employee, any capital gain is not taxed as a benefit to the employee until the employee subsequently sells the stocks. Can proceeds from a defined benefit pension plan be allocated to a lower-income spouse? A B C D Yes, the principal pensioner must petition the plan administrator in writing. No, it is never possible, because of CRA attribution rules. No, under normal circumstances the pensioner must receive all the income stream and report it personally in the year it is received. Yes, the spouse may be entitled to receive benefits from the plan based on his or her income. Government Pension Plans Pensions paid by the government are taxable as income. Reducing Income When a taxpayer s taxable income is moved from one tax bracket down to the next, tax is reduced. To help in accomplishing this step, taxable income can be reduced by pension sharing or by using income-splitting techniques. Pension Sharing When one spouse has contributed to the Canada Pension Plan, and both spouses or common-law partners are at least 60 years old, the CPP pension can be shared. This is called an assignment. N.B. The assignment of a CPP redistributes income from a pension or pensions; the amount of pension is not increased or decreased by assignment. An assignment will end: on divorce; if a non-contributor spouse becomes a contributor; on death of either spouse; or one year after the spouses separate. 366 Copyright 2011 Oliver Publishing Inc. All rights reserved.

3 Tax Strategies for Retirement Employing techniques to reduce taxes requires there to be a spouse or common-law partner who is in a lower tax bracket than the income-earning spouse. If both spouses are in the same tax bracket, income-splitting is pointless. In the case of marriage breakdown, whether legal or common-law, the spouses can divide pensionable earnings equally. The spouses must apply for the division within three years of the date of marriage breakdown. Pension Income-Splitting The pension income-tax credit of $2,000 can be used by a Canadian who receives lifetime annuity payments from a registered pension plan, a Registered Retirement Savings Plan, a Deferred Profit-Sharing Plan (DPSP), or payments from a Registered Retirement Income Fund (RRIF). Individuals who receive this credit can allocate up to one-half of the income they receive to their spouse or common-law partner. The amount allocated will be deducted from the income of the spouse who actually receives the pension and added to the income of the other spouse. Both spouses must agree to the allocation. Income-splitting Income-splitting, as seen above, is a term used to describe strategies used to save taxes by diverting income from a high-tax-bracket family member to a family member in a lower tax bracket. + FILE See File 59 on splitting income. Some of these strategies are more appropriately used prior to retirement, some following retirement, and some at any time. Regardless, clients must ensure that any strategy used is carefully documented in case of an income-tax audit. This may require each spouse to maintain a separate bank account. Copyright 2011 Oliver Publishing Inc. All rights reserved. 367

4 LLQP Rules of the Canada Revenue Agency prevent a taxpayer from transferring, loaning, or gifting property (called attribution) to a spouse or close family member to avoid or reduce tax on that property. So, if a high-income earner made a loan to his or her spouse in a lower tax bracket, any income or loss from the property, including any capital gain or loss on the disposition of the property, must be reported by the high-income earner. If the property is transferred at fair market value (FMV), attribution rules do not apply. Income-splitting between spouses can be legitimately accomplished in several ways: By employing a spouse; By increasing the investment base of the lower-income spouse; By making spousal loans; By making transfers for fair market value; By making transfers to a spousal RRSP. Why does the act of income-splitting have to be done carefully? A B C D Income-splitting could reduce income. In certain provinces, income-splitting is not allowed. Landed immigrants are not allowed to income split between spouses. Income-attribution laws are complicated and, if transgressed, can mean costly assessments, fines, and penalties. Employing a Spouse Paying the lower-income spouse a salary through a proprietorship or corporation owned by the high-income spouse is another means of splitting income. The salary must be reasonable in light of the services performed. The payment of a consulting fee to the lower-income spouse is a variation of this technique, which allows the consulting spouse to take advantage of self-employment income (e.g., writing off expenses). Neither of these methods should be used without receiving appropriate professional advice. Increasing the Investment Base of the Lower-Income Spouse Reducing the tax levied on investment assets may be accomplished by having the higher-income spouse pay the household expenses (rent, mortgage, utilities, groceries, credit-card bills, etc.), as well as the income-tax liability of the lowerincome spouse. This allows the lower-income spouse to maintain a larger investment base with which to earn future income, to be taxed at a lower rate, and to invest those funds which otherwise would be used to pay income taxes. 368 Copyright 2011 Oliver Publishing Inc. All rights reserved.

5 Tax Strategies for Retirement The higher-income spouse can pay the interest only on an investment loan made by the lower-income spouse, so long as the loan is made from a third party. No income is attributed to the higher-income spouse, while the lower-income spouse may deduct those interest payments on the loan, from his or her tax return. If you pay all the bills and your spouse, who earns less than you do, invests the extra funds he or she has as a result, you are going to benefit from those investments taxed at a lower rate and the ability to redirect money earmarked for income taxes to saving and investing. Spousal Loans Attribution rules do not apply when property or funds are loaned, provided that interest on the loan is charged at the CRA prescribed rate, and paid. Therefore, if assets are expected to produce a return well in excess of the minimum rate of interest charged, lending the assets or funds at an interest rate that avoids attribution effectively transfers the excess yield to the lower-income spouse. Transfers for Fair Market Value Since attribution rules do not apply when property is transferred for consideration equal to its fair market value, such a transfer to the lower-income spouse may be beneficial when the assets transferred are expected to increase in value or produce a high yield in the future. Contributions to a Spousal RRSP As we have seen previously, tax rules allow one spouse to contribute to the RRSP of his or her spouse (subject to the normal limits) and claim the tax deduction. It is possible that the spouse who will ultimately take the contribution into income may be in a lower tax bracket. If so, that spouse will pay significantly less tax on the income than if the other spouse had retained the contribution for his or her own plan. This strategy has become less important since pension income-splitting for RRSPs and RRIFs was introduced. Copyright 2011 Oliver Publishing Inc. All rights reserved. 369

6 LLQP To prevent immediate income-splitting, the amount contributed will be taxed back to the donor spouse to the extent of the withdrawal by the recipient spouse in the year in which it is contributed or in the next two calendar years. + FILE See File 60 for a case study of a spousal RRSP. Income-splitting is an advanced tax-planning strategy. It should only be put into use after a tax expert has been consulted. Your job as a life agent is to increase the quality of life for a client during all the phases of his or her lifetime, and that of survivors. To provide this service to your client takes your commitment, your care, and your caution. The career choice you have made is one of the best in financial services. Good luck! 370 Copyright 2011 Oliver Publishing Inc. All rights reserved.