In my travels, some people confuse the rules of pension splitting and CPP splitting so I thought I would share the 4 key differences between the two. Let’s introduce the differences with an example.
Jackie has a $2600 per month pension and she also gets $600 per month from Canada Pension Plan (CPP). Her husband Wilson is self employed so has no pension and his CPP amount is only $300 per month.
CPP splitting applies to income from CPP where pension splitting applies to eligible pension income, which does not include CPP.
Pension splitting is a one-directional split, which means Jackie can give Wilson up to half of her pension income with no expectation of returned income.
CPP is a two directional split. In other words, Jackie can give Wilson half of her CPP but Wilson must, in return, give half of his CPP back to her. In this case, they would each get $450 of CPP.
2. Distribution of income
With CPP splitting there is a physical distribution of cash. That means Jackie gets a cheque or deposit of $450 and Wilson also gets $450.
With pension splitting, Jackie does not have to give Wilson up to $1300 per month of income. The transfer is a paper transaction done on the T1032 Tax form.
3. Application process
CPP is a benefit you apply for. As a result you must apply for CPP splitting through an application process. Just like you can apply to split CPP, you can also apply to un-split CPP.
In order to apply, both spouses must be over the age of 60 and both must apply to collect CPP. Once the spouses apply for CPP, the split is determined by CPP and not the applicants. In most cases, the split is 50/50 but in the case of second marriages or late marriages, the split may not be 50/50.
With pension splitting, there is no application process. The splitting is done via the tax return and thus the amount of pension being split is determined by the taxpayer, not the government or anyone else.
Pension splitting can happen as soon as you collect pension income. In most cases, that means the age of 55 (although there are some pensions in Canada that begin before age 55).
The spouse receiving the pension does not have to be a certain age to receive pension income through pension splitting.
4. Pension income tax credit
In terms of the $2000 pension income tax credit, CPP income does not qualify as eligible income for the pension income tax credit. Only pension income qualifies for the pension income tax credit.
Eligible pension income depends on your age. If you were 65 or older in the year, pension income includes:
- Income from a superannuation or pension fund
- Annuity income out of a RRSP or a Deferred Profit Sharing Plan (DPSP)
- Income from a Registered Retirement Income Fund (RRIF)
- Interest from a prescribed non-registered annuity
- Income from foreign pensions
- Interest from a non-registered GIC offered by a life insurance company.
If you are younger than 65 for the entire year: Pension income includes:
- Income from a superannuation or pension plan
- Annuity income arising from the death of your spouse under a RRSP, RRIF, DPSP
As you can see, the rules for pension splitting and CPP splitting are very different. Can you think of any other differences between the two forms of income splitting strategies?