Tag: Age 65

Pension splitting discrimination – Charter argument fails

There are many parts of the Income Tax Act (ITA) where relevant distinctions are made as to income sources and taxpayer circumstances.  Then there are the pension income splitting rules, which suffer from irrelevant source distinctions and in turn lead to discriminatory treatment of many taxpayers.

In an informal procedure case reported this past November (Hotte v. R.), the taxpayer brought a Charter challenge to the age 65 aspect of the pension splitting rules.  

The dubious distinction in the splitting rules 

The income-splitting provisions in the ITA rely upon a number of definitions to determine what income may be included for splitting.  Chief among these definitions for these purposes:

  • All “pension income” if the person is 65 years or older; and
  • Only “qualified pension income” if the person is younger than 65.

With the exception where there is a pre-deceasing first spouse, a person whose pension income arises solely out of RRSP/RRIF sources cannot split that income until age 65.  For those who receive RPP source income, the splitting may commence before age 65.  Notably in this case, Mr. Hotte had both RPP and RRSP (life annuity) sourced pension income, and his challenge was based on the ineligibility of the latter source for splitting.

After canvassing key Charter cases, the judge stated that Mr. Hotte had not led any evidence of a “disadvantaged class” or “prejudicial stereotyping” hinging on age 65.

Court limitations where Parliament has spoken 

As acknowledged by the court, “the choice of age 65 as the threshold was a policy choice open to Parliament to make and they have made it.”  These comments flow from a letter from the Minister of Finance to Mr. Hotte that was entered into evidence.  I repeat in full here the excerpt as it appeared in the case:

“The purpose of the age-65 requirement for RRSP annuity and RRIF income is to target the Pension Income Credit (upon which eligibility for pension income splitting is based) to retired individuals. Individuals have much greater personal control over the timing of withdrawals under RRSPs and RRIFs compared to RPPs. Without the age-65 eligibility rule, many individuals who are not retired could gain significant tax advantages well before they attain age 65 by arranging to withdraw money each year as RRSP annuity or RRIF income while still saving for retirement. Individuals in receipt of RPP income, on the other hand, generally have little control over the timing of their pension payments — they usually only receive such payments when they are retired.”

Frankly, I don’t agree that there is a real concern about RRSP/RRIF holders acting in a strategic manner that is a threat to the retirement system, nor that RPP holders would fail to take advantage where possible.  On the contrary, most people would see a much greater existing financial advantage for those entitled to large pension plans – often indexed government-guaranteed defined benefit plans at that.  

In fact, the suggestion of the possibility of so-called advantages for RRSP/RRIF holders, appears to have given way to the certainty of favouring RPP holders.  Given that the actual average retirement age is closer to age 60 than 65, the reality is that RPP holders have been granted increasing favour relative to RRSP/RRIF holders.

Next time or next Budget?

Mr. Hotte made a valiant effort, but he did so self-represented under the informal procedure.  Understandably he focused upon age eligibility, but arguably it is the prior characterization of the source/definition that pre-ordains the result.  

Thus, a future taxpayer-litigant may stand a better chance by framing the issue in terms of source rather than taxpayer.  This would focus the light on the unfair structural divide in the retirement system between RRSP/RRIF holders and RPP holders.

Better yet, maybe the forthcoming Federal Budget will formally recognize this inequity and put all retirees on an even footing.

Aging and Taxation: Death is inevitable, but taxes … maybe not

We all know the over-worn adage about the inevitability of death and taxes, but just because we recite it doesn’t mean we have to stand by idly and just let it happen. 

In fact, for those who take the time to understand and manage their income sources as they age, tax burdens may be reduced or delayed.  

For those who take further advantage of options when planning their estate, surviving spouses and other beneficiaries may be delivered a gift of ongoing tax relief – all at the expense of the tax collector along the way. 

Income in retirement

Registered money

For most of us, our principal income source will be a draw from a registered plan of some sort. The most common types of such registered income plans are:

  • Life annuities from a registered pension plan (RPP);
  • Annuity payments from a registered retirement savings plan (RRSP) or deferred profit sharing plan (DPSP); or
  • Payment from a registered retirement income fund (RRIF).

While terms and investment performance will dictate how much income will actually be received, in all cases the income is fully taxable.

Non-registered savings

The tax treatment of non-registered savings will depend on investment choices and how the Canada Revenue Agency (CRA) characterizes the income derived from each. Non-registered savings income includes:

  • Fully taxable interest income;
  • Capital gains, 50% of which is taxable as income;
  • Dividend income with net tax cost generally falling in somewhere between interest and capital gains (varies by income level and marginal tax rate); and
  • Non-taxable return of capital or drawdown of capital.

The ability to choose the type of investment return and manage its timing can be a valuable tool for balancing a person’s tax bill over time.

Canada/Quebec Pension Plan

The Canada/Quebec Pension Plan provides monthly retirement benefits to pensioners, based on credits accumulated during their working years. The maximum monthly pension for 2008 is just under $885, and is fully taxable.

A pensioner may draw their full pension entitlement at 65, elect to receive an earlier, reduced base pension or delay payments to obtain a higher monthly amount later in life. Clients may elect to receive as little as 70%, beginning at age 60, or as much as 130% if they defer until after age 70. The amounts can be strategically coordinated with the timing and tax treatment of other income sources.

Old Age Security

OAS entitlement is based on years of residence in Canada after age 18.  It becomes payable upon reaching age 65, but is subject to a 15% clawback for those earning income above a minimum threshold. In 2008 this threshold is set at $64,718. A person entitled to a full OAS annual pension of approximately $6,000 will have it fully clawed back if they earn more than $105,043.

Interestingly, tax on an OAS pension may be paid monthly, where the CRA withholds taxes payable from each pension payment (electable), quarterly, which may be required by law in some circumstances, or annually – many people calculate their tax owing when filing their annual tax return. 

There are also a number of non-taxable benefit programs related to OAS, the full details of which are beyond the scope of this article. Some of these include:

  • Guaranteed Income Supplement (GIS) for low-income OAS recipients;
  • Allowance  for low-income seniors (age 60 to 64) whose spouse or common-law partner is eligible for, or currently receiving OAS and GIS; and 
  • Allowance for the survivor, a payment to low-income widowed spouses (age 60 to 64) who are not yet eligible for OAS.

Tax credits

Age amount

A person may claim the age amount beginning in the year they turn 65. The federal credit is determined by applying the lowest bracket federal rate to a prescribed amount.  For 2008, that calculation is 15% x $5,276 for an annual credit worth $791.  Similar calculations are used to determine provincial credits, which range in value from $216 to $364.

There is a 15% clawback of the federal credit for income over $31,524 in 2008. The credit is fully clawed back at $66,697. Similar clawbacks apply for provincial credits but the threshold and clawback rates vary.

Both the prescribed amount and the clawback income thresholds are indexed annually.

Pension income amount

This pension credit is determined by applying the lowest bracket federal rate of 15% to the actual eligible pension income received, to a maximum of $2,000, resulting in a maximum possible credit of $300.  In contrast to the age amount, the prescribed $2,000 amount is not indexed.  Once again, similar calculations are used when calculating provincial credits, some of them indexed, with credit values ranging between $53 and $300.

For someone 65 or older, common qualifying income types include:

  • Life annuity from a RPP;
  • Annuity payment from a RRSP or DPSP;
  • Payment from a RRIF;
  • Income component of certain annuities.

For those under age 65 the definition is more restrictive, generally being limited to:

  • Life annuity from a RPP; or 
  • Income from RRSP, DPSP or RRIF sources described above if the income comes from the death of a spouse or common law partner.

Disability amount and medical expenses

While these credits are not age specific, it is more likely they can be claimed as the client ages and feels the effect of their accumulated years.  

Amounts transferred from your spouse or common-law partner

If a taxpayer has reduced taxable income to zero but still has unused tax credits, those may be transferable to a spouse. Again, this is not necessarily an age specific issue, but may be more likely to arise for retired couples if, for example, retirement income is earned by one spouse while the other spouse has disability or medical issues.

Pension income splitting

Announced in the 2007 Federal Budget, pension income splitting is now a reality. At tax reporting time, a qualified pensioner and his or her spouse can report up to 50% of eligible pension income received on a spousal return. 

There are four principle benefits:

  • Bracket management. Shifting income from a high tax bracket pensioner to a lower tax bracket spouse can reduce net taxes paid. 
  • Old age security. Shifting reduces income for pensioners who are in the clawback range.
  • Age amount. Like OAS, the shift reduces income for pensioners over 65, who are in the clawback range.
  • Pension amount. Where the spouse does not otherwise have eligible pension income, this tax credit may be accessed. 

Bear in mind that reducing the pensioner’s income will obviously increase the transferee spouse’s income, potentially triggering clawbacks or “bracket creep” which could offset the benefits of transferring amounts in the first place. 

TFSAs

The 2008 Federal Budget put in place a new savings vehicle called a tax-free savings account, or TFSA.  Beginning in 2009, each person 18 and older will be entitled to use $5,000 of TFSA contribution room, cumulative each year, with that figure indexed upward over time. 

The simplest way to understand the tax characteristics of the TFSA is to compare it to the commonly known RRSP/RRIF arrangement:

  • RRSP/RRIF: Pre-tax money goes into the plan, no tax is paid on income earned in the registered account, all assets are fully taxable when withdrawn.
  • TFSA: After-tax money is invested, no tax is paid within the account, withdrawals, including gains, are100% non-taxable coming out.

The TFSA could have great value for those past their income earning years, who are no longer accumulating RRSP room, especially for those past age 71 when RRIF minimum payouts force the depletion of other tax sheltered funds.

Testamentary trusts

Testamentary trusts can be created for your spouse or any other beneficiary using your will. The key tax benefit of this type of trust is that a separate taxable entity is entitled to graduated tax bracket treatment. This allows and facilitates income splitting opportunities between the trust and its beneficiaries, especially wealthy beneficiaries.  In effect you are lending a part of your legal personality to an ongoing trust that may last for years or even decades into the future. 

That’s one way that you may be gone but not forgotten – at least in a tax sense.