Using that nice little pension tax credit
Canadians have some important traditions…hockey, shovelling snow and politeness (Except when we get behind the wheel of a car. We’re not always polite when we’re driving).
There’s also the common goal of tax avoidance.
Don’t confuse tax avoidance with tax evasion. Evasion is illegal; don’t do that. Tax avoidance is the reduction of the taxes we pay by any available legal means. I believe that it’s our duty as Canadians to pay as little in taxes as is legally possible.
Not a lot of tax-avoidance strategies are available, but the pension tax credit is a useful one for retirees. It provides taxpayers age 65 or older with a federal credit of 15 per cent of qualifying pension income of up to $2,000 of income each year. A smaller credit is available in Quebec.
Related article: Paying less tax means more money in your pocket
Let me try to simplify what is a rather complicated tax matter. Taxes, complicated? Who knew?
What is considered Pension Income?
This must be “private pension income received through a life annuity,” according to KPMG’s useful little book, Tax Planning for you and Your Family 2014.
“To make the most of this credit,” the KPMG book says, “you should aim to have at least $2,000 of qualifying pension income annually, plus another $2,000 for your spouse, if possible.”
The Income Tax Act specifies that this can include income from an employer pension plan, as well as “annuitized” income from an RRSP, a deferred profit-sharing plan or the income portion from a regular annuity. Income payments as a result of your spouse’s death also qualify.
Related article: Are you taking advantage of the pension tax credit?
Annuitized RRSP income is income taken when an RRSP is turned into a RRIF or an annuity. All you have to do is instruct your financial institution to convert all or a portion of an RRSP into a RRIF. RRSP withdrawals don’t qualify; rather, it must be RRIF income. To take advantage of the pension income credit, you may not want to mature all of your RRSPs at once (especially if you’re still working), but you could take just enough income to provide the $2,000 of annual tax-free income.
How can you create pension income?
If you don’t have a pension plan from work, you can create pension income with your RRSPs. Discuss this with your accountant or tax preparer and your financial planner, but consider this strategy. For ages 65 through 71, if you haven’t already chosen to convert your RRSP, flip $12,000 into a RRIF and take income of $2,000 each year. At age 71 you then must convert any remaining RRSPs that you have and you’re required to start taking income payments at age 72.
Related article: How to Convert Your RRSPs to RRIFs
This tax-free income doesn’t accumulate so if you miss a year you lose that year’s tax-free income. Your savings can mount to become pretty substantial over many years, especially when a spouse also does this.
Also, when you combine this with strategies such as the effective use of RRSPs, TFSAs and various means of income splitting, you can achieve some hefty tax savings.
Related article: Income splitting strategies in retirement
Ask your tax preparer if it’s to your advantage to RRIF your RRSP at age 65 instead of waiting until 71.