Weekly Tax Tip – Income Splitting With Canada Pension Plan (CPP) Benefits

‘Equal’ is a helpful word to remember when going about reducing taxes payable. The  more equal spousal incomes are to one another (i.e. the smaller the difference in income for each spouse), the lower taxes payable will be. Take for example Ethan and Olivia, a couple that earn combined income of $100,000. If Olivia earns $80,000 and Ethan earns $20,000, in Ontario taxes payable will total $19,208 ($17,425 for Olivia and $1,783 for Ethan). However if both earn $50,000 for a combined income of $100,000, each will owe $8,405 or $16,810 in total. The savings of $2,398 is due to Canada’s progressive tax system whereby the tax rate increases as the amount of taxable income earned increases.

In reality, a spouse would not willingly reduce their employment earnings to match the other spouse, however, in retirement, when employment income is no longer part of the financial equation, any act to equalize income becomes a valuable way to save tax. Specifically when it comes to CPP, a couple can make an election to split the benefits that accrued during the time they lived together 50% – 50%. More information can be found here: Pension Income Splitting.

This election will be especially handy if one spouse was a homemaker. Here’s why: half of working spouse’s CPP will be taxable in the hands of the spouse that did not work. So assuming the homemaker’s only income is CPP, they will be subject to very little if any tax. This creates the potential for substantial savings over years in which CPP is collected as 50% of the CPP benefit would otherwise have been taxed in the hands of the working spouse at their highest marginal rate.