The New RRIF Rules and Pension Income Splitting

Recent changes to RRIF withdrawal rules are in the spotlight since the April 21, 2015 federal budget.  Will they affect pension income splitting, and if so, how? 

The short answer is yes, as there is now a new opportunity to determine the optimal amount to be split.

But first, some background.  Since tax year 2007, seniors have been allowed to split pension income eligible for the pension income amount with a spouse or common-law partner. This includes income from a Registered Pension Plan, regardless of the annuitant’s age, and an RRSP annuity, a DPSP annuity, a RRIF withdrawal or a RRIF withdrawal, but only if the recipient is 65 or older.

Retirement income that cannot be split includes OAS and GIS receipts, CPP and QPP receipts and, if the annuitant is under 65, RRSP withdrawals, RRSP or DPSP annuities, and RRIF withdrawals.

Taxpayers who are between the ages of 65 and 71 who have no other source of income eligible for the pension income amount should consider converting some of their RRSP balances to RRIFs.  By doing so, they can maximize the minimum amount that can be received tax free - up to $2,000 per year under the pension income amount.

Taxpayers who are not in the highest tax bracket but whose spouses will be at death should consider this a first step in a tax-efficient RRIF melt-down strategy. By removing enough money from the RRIF to top their income up to just below the highest tax bracket, the taxes payable on the withdrawals will be less than the taxes payable in the year of death.  The strategy is increasingly important in provinces with new provincial surtaxes.

Here’s a brief example:

Emma and Josh are in their 70s.  Josh’s RRIF balance is $300,000 and he receives $10,000 CPP, OAS, and he has investment income of $50,000 annually.  Emma’s only income is from OAS.  Josh’s minimum RRIF withdrawal is $17,010.  With electing to split his pension income with Emma, Josh is still squarely in the middle of the 21% federal tax bracket and Emma is in the lowest bracket.  On average they’re paying about 24% (federal plus provincial) on Josh’s RRIF withdrawals.

When the last spouse passes away, the RRIF balance will be taxed at the 29% federal rate unless the balance is reduced below $136,270 (2014 bracket).  The combined tax rate on the RRIF income in the year of death could be 45% or more depending on their province of residence.

If Josh withdraws an extra $30,000 each year from his RRIF, his federal tax rate would remain at 21% (33% combined federal and provincial).  This means that the couple will pay tax now at about 32% (Emma’s rate is lower) instead of paying tax later at 45%.  The excess amounts not required for living expenses should be saved in a TFSA so that the income earned remains sheltered.  Once the first spouse passes away, excess withdrawals will have to be reduced because pension income splitting will no longer be available. 

To compute the effect of RRIF planning on taxable income using pension income splitting, Knowledge Bureau has developed two specific tax calculators to help:  The Income Tax Estimator and the Tax Efficient Retirement Income Calculator, available at a 15% discount throughout the month of May for a one year subscription. Click the links for the discounted calculator.

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