2022 was a year of almost unrelenting bad financial news for Canadians, but perhaps no group was more affected by those changes than retirees who rely on income from unindexed pensions and from returns on invested savings. Most such retirees saw the value of their investments decline, as the S&P/TSX Composite Index dropped by over 8% during 2022. At the same time retirees had to cope with inflationary increases in the cost of most goods, including double digit percentage increases in the cost of food. Those who owned their own homes saw the value of those homes drop, on average, by 12% between December 2021 and December 2022. And, finally, retirees who carried debt were likely to be paying significantly more interest on that debt by the end of 2022 than they were at the beginning of the year.
With the 2022 calendar year behind us, those retirees must now prepare to file their tax returns for that year and face the prospect of having a tax bill to pay. Income tax is a big-ticket item for most retired Canadians and, especially for those who are no longer paying a mortgage, the annual tax bill may be the single biggest expenditure they are required to make each year. Fortunately, there is some good news for such retirees, as the Canadian tax system provides a number of tax deductions and credits available only to those over the age of 65 (like the age credit) or only to those receiving the kinds of income usually received by retirees (like the pension income credit), in order to help minimize that tax burden. What follows is an outline of the most common such deductions and credits which may be claimed by those over 65.
Most tax savings strategies (like charitable contributions) require an expenditure on the part of the taxpayer and must be completed prior to the end of the tax year. That’s not the case with any of the following tax saving credits, which simply need to be claimed on the annual return to filed in the spring of 2023.
All Canadians who were age 65 or older at the end of 2022 can claim the age credit on their tax return for the year. For 2022, that credit amount is $7,898 which, when converted to a tax credit, reduces federal tax by $1,184.70.
While the age credit can be claimed by anyone aged 65 or older, the amount of credit claimable is reduced where the taxpayer’s income for 2022 was more than $39,826. Where that is the case, the available credit is reduced by 15% for each dollar of income over that $39,826 threshold amount.
Pension income credit
Most Canadians who are aged 65 or older receive income some kind of private pension income which would qualify for the pension income credit. For purposes of that credit, amounts received from an employer-sponsored pension plan qualify, but so too do amounts received from a registered retirement savings plan (RRSP) or a registered retirement income fund (RRIF). Amounts received from government-sponsored retirement income plans (like the Canada Pension Plan or Old Age Security) do not, however, qualify.
Where the taxpayer receives amounts that qualify as pension income for purposes of the pension income credit, the first $2,000 of such income is effectively exempt from federal tax. In addition, unlike the age credit, the total income of the taxpayer does not limit a claim for the pension income credit in any way.
Disability tax credit
It’s not necessary to be over the age of 65 in order to claim the disability tax credit, but many taxpayers who are in that age group may be able to qualify. The DTC cannot be claimed on the annual tax return, however, unless an individual has previously been approved by the Canada Revenue Agency as someone who meets the required criteria.
In order to be approved as someone eligible to claim the disability tax credit, an individual must generally have significant loss of function in specified activities necessary for daily life, like vision or mobility. The process for being approved as eligible for the disability tax credit is not a quick one and so is unlikely to be claimable for 2022 by anyone who has not already been approved by the CRA.
However, taxpayers who believe that they may qualify should consider starting the process of applying for such approval. That process generally starts with an individual’s health care provider, who can complete the necessary form detailing the extent of the individual’s loss of function. While the process takes months, starting now could mean, where the application is approved, that the DTC can be claimed on the return for 2023.
The DTC is a significant credit, as the credit amount for 2022 is $8,870, and the reduction in federal tax payable is $1,330.50.
Pension income splitting
The credits listed above are generally flagged on the annual return form or in the tax guide. There is, however, another income tax saving strategy available to older Canadians, but it is not nearly as well known and, unfortunately, isn’t readily apparent from either the tax return form or the annual income tax guide. That tax saving strategy is pension income splitting and it’s likely the case that many taxpayers who could benefit aren’t familiar with the strategy, especially if they are not receiving professional tax planning or tax return preparation advice.
That’s a particularly unfortunate reality because pension income splitting has the potential to generate more tax savings among taxpayers over the age of 65 (and certainly those over the age of 71, for whom RRSP contributions are no longer possible) than just about any other tax planning strategy available to older Canadians. And, unlike most tax saving strategies, pension income splitting does not require any expenditure of funds or any advance planning on the part of the taxpayer.
When described in those terms, pension income splitting can sound like one of those “too good to be true” tax scams, but that’s not the case. Essentially, what pension income splitting offers is a government-sanctioned opportunity for Canadian residents who are married (and, usually, where one spouse is aged 65 or older) to make a notional reallocation of private pension income between them on their annual tax returns, and to benefit from a lower overall family tax bill as a result.
Pension income splitting, like all forms of income splitting, works because Canada has what is called a “progressive” tax system, in which the applicable tax rate goes up as income rises. For 2022, the federal tax rate applied to about the first $50,000 of taxable income is 15%, while the federal rate applied to approximately the next $50,000 of such income is 20.5%. So, an individual who has $100,000 in taxable income would pay federal tax of about $17,750: if that $100,000 was divided equally between such individual and his or her spouse, each would have $50,000 in taxable income and federal tax payable of $7,500 each. The total federal family tax bill would be $15,000, meaning a permanent federal tax savings of $2,750.
The general rule with respect to pension income splitting is that a taxpayer who receives private pension income during the year is entitled to allocate up to half that income (without any dollar limit) to his or her spouse for tax purposes. In this context, private pension income means a pension received from a former employer and, where the income recipient is age 65 or older, payments from an annuity, an RRSP, or an RRIF. Government source pensions, like the Canada Pension Plan, Quebec Pension Plan, or Old Age Security payments do not qualify for pension income splitting, regardless of the age of the recipient.
The mechanics of pension income splitting are relatively simple. There is no need to transfer funds between spouses or to make any change in the actual payment or receipt of qualifying pension amounts, and no need to notify a pension administrator. Taxpayers who wish to split eligible pension income received by either of them must each file Form T1032, Joint Election to Split Pension Income, with their annual tax return. That form for the 2022 tax year, which is not included in the annual tax return package, can be found on the Canada Revenue Agency website at https://www.canada.ca/en/revenue-agency/services/forms-publications/forms/t1032.html or can be ordered by calling 1-800-959 8281.
On the T1032, the taxpayer receiving the private pension income and the spouse with whom that income is to be split must make a joint election to be filed with their respective tax returns for 2022. Since the splitting of pension income affects the income and therefore the tax liability of both spouses, the election must be made and the form filed by both spouses – an election filed by only one spouse or the other won’t suffice. In addition to filing the T1032, the spouse who is actual recipient of the pension income to be split must deduct from income the pension income amount allocated to his or her spouse. That deduction is taken on Line 21000 of their 2022 return. And, conversely, the spouse to whom the pension income amount is being allocated is required to add that amount to their income on the return, this time on Line 11600. Essentially, to benefit from pension income splitting, all that’s needed is for each spouse to file a single form with the CRA and to make a single entry on their 2022 tax return.
By the end of February or early March, taxpayers will have received (or downloaded) the information slips which summarize the income received from various sources during 2022. At that time, couples who might benefit from this strategy can review those information slips and calculate the extent to which they can make a dent in their overall tax bill for the year through pension income splitting.
Those wishing to obtain more information on pension income splitting than is available in the 2022 General Income Tax and Benefit Guide should refer to the CRA website at http://www.cra-arc.gc.ca/pensionsplitting/, where more detailed information is available.
The information presented is only of a general nature, may omit many details and special rules, is current only as of its published date, and accordingly cannot be regarded as legal or tax advice. Please contact our office for more information on this subject and how it pertains to your specific tax or financial situation.