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Retirement savings

April 21, 2014

Does your pension income qualify you for a tax credit?

If you received pension or annuity income last year (even if you’re under age 65) you may be eligible to receive a tax credit.

Several provinces also offer the credit, so depending on your province of residence, you may be entitled to more.

According to figures from the Canada Revenue Agency, the credit is widely used. For the 2009 tax year, 4.6 million Canadians over the age of 65 filed tax returns, and 3.1 million claimed the pension income tax credit. Don’t be fooled by its name, though: This credit isn’t just for seniors. Almost 1.2 million Canadians were under 65 when they claimed the credit for 2009. And many maximized the credit — the average claim was for $1,900 worth of pension or qualifying pension income.

Here’s how it works. You can claim the credit on up to $2,000 of eligible pension income. The credit is non-refundable, and is calculated at the 15% federal and at the lowest provincial rate. That means you will get a reduction in the amount of federal tax you owe of up to $300 ($2000 x 15%). You may also get a reduction in the amount of provincial tax you owe. "Non-refundable" means that the credit can only be used to the extent that it reduces your tax liability to zero. If you owe less in the tax than the amount of the credit, some of the credit will be wasted.

What type of income qualifies? It’s a long list.

If you turned age 65 during the tax year or are older, pension income eligible for the credit includes:

  • Payments in the form of a life annuity from a pension plan. This includes defined contribution and defined benefit plans, and the Saskatchewan Pension Plan. Payments from these plans in any form other than a life annuity aren't eligible for the credit.
  • Annuity payments from a registered retirement savings plan (RRSP), a deferred profit-sharing plan (DPSP) or a pooled registered pension plan (PRPP). Payments must be annuity payments; lump-sum withdrawals won’t qualify. But the annuity payments don't have to be life annuity payments — term-certain annuity payments also qualify (but make sure that the term-certain annuity also obeys the rules governing registered plans).
  • Payments from a registered retirement income fund (RRIF) or a life income fund (LIF). Payments don't have to be in the form of an annuity. Any type of payment -- lump-sum withdrawal, interest only, minimum formula -- qualifies.
  • The taxable part of a non-registered annuity. It doesn’t matter whether the annuity is a deferred or payout annuity or, if a payout annuity, whether taxation is level or not.

If you were under 65 for the whole tax year, income eligible for the credit also includes:

  • Payments in the form of a life annuity from a pension plan (including defined contribution and defined benefit plans, and the Saskatchewan Pension Plan, but not including a pooled registered pension plan).
  • Any of the payments noted above if they are received as the result of a spouse’s or common-law partner’s death.

Not all pension income is eligible, though. For example, if you receive pension income from a country that has a tax treaty with Canada, you can’t claim the income if the treaty defines the income as tax-free. Similarly, Old Age Security, Canada Pension Plan, Quebec Pension Plan and death benefits are ineligible. So are retiring allowances and RRSP withdrawals (other than annuity payments). Payments from a salary-deferral arrangement, retirement compensation arrangement, employee benefit plan or employee benefit trust are also ineligible.

Closely related to the pension income tax credit is pension income splitting. You can split up to half of your eligible pension income with your spouse or common-law partner. If that person is in a lower tax bracket, you can save the difference in tax. The same income that qualifies for the pension income tax credit also qualifies for pension income splitting. The same age restrictions also apply.

If you take advantage of income splitting and the pension income tax credit, you can save thousands in taxes over your lifetime. But the pension income tax credit is a non-refundable tax credit, which means you can’t carry the credit forward if you don’t use it. (You can, however, transfer unused amounts to your spouse or common-law partner.) Needless to say, this is an area where you’re well advised to consult with your financial advisor and/or accountant. 

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