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Barry's
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Devolin Column
November 2, 2006
Who will Benefit from Pension Splitting
Earlier this week, Finance Minister Jim Flaherty made a major announcement regarding pension splitting, seniors’ tax credits, corporate tax rates and the tax treatment of income trusts. Not surprisingly, most of the media focus was on income trusts, and the immediate impact that had on the stock market.
A second major component in this announcement was the decision to allow Canadians to split pension income within their family. This is a major change in tax policy – and many retired middle-class Canadians are going to get a well-deserved boost in their take-home pension income.
So, what is pension income splitting? Who will benefit? How much will they benefit?
Currently, individuals pay income tax based on their personal income. If Canada had a flat income tax rate in Canada, this would mean that a person making $30,000 would pay double the income tax of someone making $15,000.
However, due to the progressive nature of our income tax system, those with higher incomes pay a higher percentage of income tax. This means that someone making $30,000 actually pays more than twice as much income tax as someone making $15,000.
This progressive nature of our income tax system has major consequences for retired couples where one person has significant pension income, while their spouse has little or no income of any kind.
Here is an example to demonstrate this point:
Couple A includes a husband and wife who both worked for major employers that had fixed benefit pension plans. These could be retired teachers, or GM workers, or bank or municipal employees – and both have earned pensions of $30,000.
Couple B includes one person who receives a pension of $45,000 annually. Their spouse, on the other hand, was either self-employed or spent years working in a small business where there was no pension plan. Consequently, they receive some Canada Pension Plan income and may have small RRSP investments resulting in an annual income of $15,000.
Couple C includes one person who worked in a senior capacity and has earned a pension of $60,000 per year. However, their spouse was a homemaker and spent years as a full-time parent at home. They have little CPP benefits, no retirement savings, and consequently no income.
Each of these three couples has household pension income totaling $60,000 per year – and you might think they pay similar amounts of income tax. Not true.
As it turns out, Couple A with two $30,000 pensions pays the least income tax, Couple B with the $45,000 and $15,000 incomes pays about $2,000 more, while Couple C with a single income of $60,000 pays about $3,000 more each year in income tax.
This is where pension income splitting would level the field for all three couples. By allowing each of these couples to pool their $60,000 household incomes and then split them in two equal portions of $30,000 for tax purposes, the tax burden would be equal at the lowest level.
As my example demonstrates, this change will results in major tax savings of thousands of dollars each year for tens of thousands of couples living on pension income across Canada.
This is good news for the thousands of retired couples – including many in Haliburton-Kawartha Lakes-Brock – and brings a new level of fairness to Canada’s income tax system.
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