Taking Advantage of the Pension Income Tax Credit
Many Canadians may be unaware of a relatively straightforward tax planning strategy to take advantage of the Pension Income Tax Credit, starting at age 65 (instead of at 71).
The Pension Income Tax Credit allows taxpayers aged 65 or older to claim a tax credit on up to $2,000 of eligible pension income per calendar year, saving the taxpayer a maximum of $300 per year in federal taxes plus applicable provincial taxes (about $130 annually in Ontario). Of course, a taxpayer needs to have eligible pension income to claim the tax credit which usually means they need to draw income from a registered retired income fund (RRIF), unless they are already receiving benefits from a pension plan or annuity.
Recapping quickly, Canadians who hold RRSPs (registered retirement savings plans) must transfer those assets to a RRIF no later than the end of the year in which they turn 71. Thereafter, RRIF rules stipulate that a minimum percentage of the value of the RRIF be withdrawn each year thereafter and claimed as taxable income (see the minimum RRIF withdrawal schedule here).
Though 71 is the age at which RRSP assets must be transferred to a RRIF, taxpayers may choose to do a full or partial transfer earlier for a variety of reasons, including taking advantage of the Pension Income Tax Credit.
Consider this simple case scenario: at age 65, Marilyn, a semi-retired doctor living in Ontario with enough income to fulfill her lifestyle, voluntarily opens a RRIF account and transfers just $12,000 from her $1 million RRSP to her newly opened RRIF account. Going forward, Marilyn draws $2,000 annually from her RRIF over the next six years until she reaches 71, allowing her to fully utilize the Pension Income Tax Credit.
Assuming Marilyn is in the highest marginal tax bracket, this would allow her to save approximately $2,600 in federal and Ontario provincial income tax over the six-year period. If she is married and Marilyn’s spouse pursues the same strategy, they could save as much as $5,200 on a combined basis.
It is important to keep in mind that the pension income must come from either a RRIF, annuity or pension plan (not an RRSP) to utilize the Pension Income Tax Credit. If eligible pension income is already earned from one of these sources, early RRSP conversion may not be warranted.
Please feel free to contact us if you would like to discuss this strategy in more detail.