Making dollars and sense out of pension income splitting · Making dollars and sense out of pension income splitting … CIFPs 7th Annual National Conference June 8, 2009 Lea Koiv,

Making dollars and sense out of pension income splitting …

CIFPs 7th Annual National Conference

June 8, 2009

Lea Koiv, B.Comm., CMA, CA, CFP, TEPSenior Advisor, Taxation

[email protected]

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Pension Splitting Rules

§ First announced October 31, 2006 as part of the Tax Fairness Plan (same date as new measures re income trusts were announced)§ Legislation enacted on June 22, 2007§ New rules are applicable for 2007 and later

taxation years§ It’s too late once you are at the accountant’s

office having tax return prepared!

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Pension Splitting Rules

§ Rules are of wide application§ No requirement that taxpayer be “retired” – only that

he/she have a source of income qualifying for the split

§ Significant tax savings may result where rules can be applied§ Essentially, enhances yield where qualifying

products are acquired§ Taxpayers and their advisors need to know:§ which products to acquire§ concepts to use

§ Legalized income splitting – avoid application of income attribution rules!

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Pension Splitting Proposal

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Potential Tax Savings (Ontario)

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Who qualifies for pension splitting?

§ “Pensioner”§ Resident in Canada on Dec. 31st (or

immediately prior to death)§ In receipt of “eligible pension income” in

the taxation year§ While no requirement with respect to age

of “pensioner”, what may be split varies with age

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Who qualifies for pension splitting?§“Pension transferee”:§ Resident in Canada on Dec. 31st (or immediately

prior to death)§ Must be married to or in a common-law relationship

with “pensioner” at any time in taxation year § Cannot be a “pension transferee” if there was a

breakdown on the marriage/common-law partnership and the pension transferee was living separate and apart from the “pensioner” at the end of the taxation year (or for a period of at least 90 days starting in the taxation year)§ No requirement with respect to age of pension

transferee

What Qualifies for Splitting for Age 65 Recipient?

§ “Pension income” includes:

1) A life annuity out of or under a pension plan (including Individual Pension Plan)§ Must be paid directly from plan or plan sponsor

may purchase annuity from insurer § Includes amounts paid from foreign plans (incl.

government plans*)§ Lump-sums do not qualify§ Take care with transfers out of RPP – may lose

access to source until age 65

*excludes IRAcont’d …

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2) An annuity under a Registered Retirement Savings Plan (RRSP) (incl. LIRA) or “amended plan”§ Life annuity or term certain annuity to age 90§ Lump-sums from RRSPs do not qualify!§ Watch out with amounts unlocked from

Federal RLIFs, New Ontario LIFs, etc.§ “Two-step” (transfer to RRIF/LIF) may be

appropriate

cont’d …

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3) A payment out of or under a Registered Retirement Income Fund (RRIF) (incl. LIF/LRIF) or “amended plan”§ Taxable withdrawals (minimum or

maximum), including payments to successor annuitants

4) A payment that is similar to a RRIF from a Defined Contribution pension plan

cont’d …


5) An annuity payment under a Deferred Profit Sharing Plan (DPSP) or “revoked plan”§ A life annuity acquired from a licensed

insurer

6) An instalment payment from a DPSP§ Instalments paid to member in up to a 10-

year period

cont’d…


7) Prescribed annuities § Immediate/Life & Term Certain

8) Non-prescribed annuities offered by insurers§ Term fund products § Deferred annuities§ Life & Term Certain

7) & 8) provide insurers with unique opportunities in the Pension Splitting area

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What Qualifies for Splitting for Recipient Who is Not Yet 65?

§ “Qualified Pension Income” includes:

§Item 1) from above (including bridging benefits from an RPP)

§Any of items 2) to 8) that are received because of the death of a spouse or common-law partner

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What Does Not Qualify for Splitting?

Specific exclusions include:

§ OAS§ CPP (or provincial plans such as QPP)*§ Amounts qualifying as “pension income” or

“eligible pension income”, but against which a deduction was taken§ Supplemental pension plans (funded or

unfunded)§ Salary Deferral Arrangements

* Subject to “sharing” under a different set of rules

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Prescribed vs. Non-Prescribed Annuities

• Prescribed Annuity Contracts (PACs)• Tax-efficient – enjoy level taxation• Once insurer establishes split between capital and interest, same split applies to allpayments

• Need to meet specific conditions in ITA in order to qualify as a prescribed annuity

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• Non-Prescribed Annuity Contracts (Non-PACs)• Less tax-efficient (except perhaps for impaired annuities)

• Taxed on a policy year basis• Typically no income inclusion for first year(s), since expenses are offset income inclusion

• Income inclusion generally declines over period

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Turning Interest Income into Pension Income

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Term certain annuity with new pension splitting rules

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How Much Can be Transferred?

“Split-pension amount” limited to:

0.5A x B/C

Where:A is pensioner’s “eligible pension income” for

the yearB is the # of month parties married to each other

(or in common-law relationship)C is the # of months in the pensioner’s tax year

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Mechanics of the Process

Joint election process§Form T1032 – Joint Election to Split Pension Income must be completed and filed (or retained on file, if taxpayer e-files)§Election can vary year to year§Late filing provisions have been introduced

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Potential Doubling of the Pension Credit

§With reallocation, amount transferred to spouse or common-law partner retains identity§May result in spouse or common-law partner

now having a source of income for purposes of claiming the (non-refundable) pension tax credit§Essentially, pension credit will be doubled if

“pension transferee” would have had access to pension credit had they received the income directly

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Impact on Age Amount

§The Age Amount is a (non-refundable) tax credit available to taxpayers who are age 65 or older at year-end §Maximum value (2009) – approx. $1,300

§This tax credit is income tested§Each $1 of net income above a threshold amount reduces Age Amount by $0.15§ 2008 - $31,524§ 2009 - $32,312

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How Can You Maximize Your Position?

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Advantages of Insured Products?

We have focused on:§ Potential for Pension Tax Credit Eligibility § Pension Splitting Opportunities

Also remember that these products provide for:§ Privacy§ Beneficiary Designation§ Probate Bypass Opportunity§ Potential for Creditor Protection§ Deposit Protection*

* As provided by Assuris

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Some Case Studies

§The commutation decision§An IPP solution§Other solutions – concepts using annuities

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The Commutation Decision

Case Study #1

§ Mr. D (DOB July 24/57)§ Member of RPP subject to Ontario pension

standards legislation§ Proposed Retirement June 1/09

Decision to be made:

§ Take monthly pension from RPP versus commute pension

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Case Study #1

§ Monthly pension§$3,855 per month (incl. bridging benefit of $1,054

payable to age 65)

§ Commuted valueTransfer to locked-in vehicle $459,805 (61%)Taxable amount 297,957 (39%)

$757,762

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Factors to be assessed:

§ Switching client from defined benefit (DB) to defined contribution (DC) environment§Longevity risk?§ Investment risk?§ If commute, risk mitigation via appropriate product

allocation (some portion in annuities?)§ Retirement income flows under both options§With commutation, can same level of income be

derived?

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Factors to be assessed – cont’d:

§ Estate preservation§Assess impact of guarantees made available by RPP§ What if single?§ What if both spouses die after expiry of these

periods§ Insurance?

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§ Taxation of commuted value§Where amounts transferred from a DB RPP to a DC

arrangement, application of Regulation 8517 results in significant taxes payable on amount that cannot be transferred to locked-in vehicle

Non-transferable amount $297,957Taxes thereon @ 46.41%* (132, 282)

Remainder $165,675

*Top Ontario tax rate

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§ Taxation of commuted value§ Impact of Reg. 8517 can be mitigated if:§ Taxpayer has unused RRSP room, or§ A Pension Adjustment Reversal (PAR) arises

§Remember:§ Excess RRSP contributions result in a penalty§ Insufficient withholdings re lump-sum – need to

set aside cash for next April 30th§ Lump-sum is not splittable

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§ Application of pension splitting rules§Pension payable by RPP is splittable at any age§ Potential tax savings § Both spouses (any age) can access Pension

Credit§Annuity acquired directly with funds from RPP is also

splittable§Lose access to pension splitting until age 65 where

amounts are transferred to a locked-in vehicle§ An annuity acquired with funds from locked-in

plan or LIF withdrawals only qualify in year taxpayer attains age 65

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Commutation Decisions


§ Increased Flexibility§ If DB RPP pays pension, income stream generally

fixed (except if indexation, certain spousal forms, etc.)§Taking commuted value§ Provides for greater flexibility in income stream§ Possible additional unlocking of locked-in

amounts (e.g., Ontario’s New LIF, etc.)§ Remember to do “two-step”, where

appropriate

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Commutation Decisions


§ Solvency of RPP§For Ontario plans need to assess potential added

protection offered by Pension Benefits Guarantee Fund (PBGF)

§ Impact on post-employment and other benefits§ Special needs §Accessing cash to pay off debt?§Accessing cash for other special needs?

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What did Mr. D do?

§ Section 147.4 annuity§Commuted value can be used to acquire an annuity

directly with plan funds that is not materially differentfrom what the RPP would have paid§ Avoids application of Regulation 8517§ Pension splitting achieved

§Where “materially different” requirement is not met, full amount of commuted value is taxable!§Remember, that requirements of pension standards

legislation must also be met where such annuities are acquired

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What did Mr. D do?

§Section 147.4 annuity – cont’d§Section 147.4 does not apply where annuity acquired from RRSP/RIF (locked-in or other)§Annuities from these plans need to meet

conditions for:§Registered annuities§Any requirements of pension

standards legislation

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The IPP Solution

Case Study #2

Mr. J (June 1/47)Incorporated J Co in 1988Mr. J owns 100% of shares of J CoOnly started drawing salary in 1993Has accumulated RRSP assets of $850,000 Contemplating selling his company in next few years

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The IPP Solution

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The IPP Solution

Dual Component IPP

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The IPP Solution

Benefits of Dual Component IPP

DB Component§ DB component provides “Cadillac” (best) benefit that an

DB RPP can provide§ Tax-deductible contributions to company for:§Current service§Past service§Certain shortfalls in investment performance§Future terminal funding

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The IPP Solution


DB Component – cont’d§ Tax-deductible administrative and other costs§ “Cleansed” corporation of excess passive assets and

mitigated risk of loss of access to $750,000 capital gains exemption§ Pension benefit (including any CPP bridging benefits)

will qualify for income splitting

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The IPP Solution


DC Component§ Tax-deductible administrative and other costs (incl.

management fees)§ If annuitize this component, pension benefit will qualify

for income splitting§ Potential for reduced management fees, since larger

asset accumulation in one plan

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Individual Pension Plans

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Other Solutions

§ Concepts Using Annuities Pension § Splitting should be folded into

concepts using annuities for taxpayers age 65+§ The back-to-back or Insured Annuity§ Combination of prescribed annuity

(PAC) + life insurance§ The Tax Deferred Annuity§ Combination of Term Certain annuity

+ segregated funds/mutual funds

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The Insured Annuity

§ The concept itself:§ Suitable for client seeking security and who is

also concerned with capital preservation§ Acquire insurance policy to provide for capital

going to estate, with balance of funds invested in Prescribed Annuity

§ Annuity provides income stream, plus source of funds for payment of insurance premiums

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The Insured Annuity

§ Why this creates value for the client:§ Tax efficiencies:§ Prescribed annuities enjoy level taxation§ Amount included in taxable income is reduced

because of return of capital§ Lower tax bracket? § Reduced clawbacks of Age Amount and

OAS?§ Access to Pension Credit?

§ Pension Splitting rules apply for policyholders who are age 65+

§ Guaranteed income stream

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Another Look at Concepts Using Annuities

§ The “old chestnut” – Back-to-back or Insured Annuity as it is usually modeled (45% tax rate used) – assumes capital is his

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§ The “old chestnut” – Back-to-back or Insured –using true tax rates (51.9%) (no pension splitting)

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Another Look at Concepts Using Annuities§ The “old chestnut” – Back-to-back or Insured –using

true tax rates (51.9% him, 21.05% her) (with pension splitting)

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The Tax-Deferred Annuity

§ The concept itself:§ Suitable for client seeking security and who is

also concerned with capital preservation§ Look at after-tax income from GIC§ Replace annual income stream with Term

Certain Annuity, with balance of capital invested in Segregated Funds or Mutual Funds

§ Segregated Fund guarantees assist with capital preservation

§ Potential upside with respect to equity-type investments

§ Segregated funds/mutual funds represent a source of cash for meeting special needs

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The Tax-Deferred Annuity

§ Why this creates value for the client:§ Upside re investment performance§ Tax efficiencies:§ Annual income inclusion should fall because

taxable income falls § Lower tax bracket? § Reduced clawbacks of Age Amount and

OAS?§ Access to Pension Credit?

§ Pension Splitting rules apply for policyholders who are age 65+

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§ The Tax Deferred Annuity (TDA) as it is usually modeled

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§ The Tax Deferred Annuity (TDA) showing different tax rates for GIC and Annuity

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§ The Tax Deferred Annuity (TDA) folding in Pension Splitting

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Where to Find More Materials

§All materials are available in Advisor Source:http://www.advisors.standardlife.ca/

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Standard Life

With 10,000 employees globally, Standard Life plc is a major international financial services group headquartered in Scotland. It provides asset-managing services for retirement, investment and protection to some 6.5 million customers globally. It had C$278.3 billion in assets under administration, as at December 31, 2008. It has offices in the United Kingdom, Canada, Ireland, Germany, Austria, India, China and Hong Kong.

The Standard Life Assurance Company of Canada is Standard Life plc’s largest operation outside the U.K., with 2,000 employees based in Montreal and across Canada, serving more than 1.3 million Canadians, including group insurance and pension plan participants.

Standard Life plc has approximately 1.5 million shareholders worldwide, including approximately 14,000 institutional and individual shareholders in Canada. It has been trading on the London Stock Exchange since The Standard Life Assurance Company demutualized in 2006. Standard Life plc is listed on the FTSE 100, Europe’s largest index, and on the FTSE4Good Index, which identifies companies adhering to globally recognized corporate responsibility standards.

Documents

Making dollars and sense out of pension income splitting · Making dollars and sense out of pension income splitting … CIFPs 7th Annual National Conference June 8, 2009 Lea Koiv,