Making the most of the pension tax credit

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I liked your coverage of RRIF taxation. I would like to see more information on LIF taxation. More precisely, on the following scenario: Individuals do not get the $2,000 tax credit for RRIF withdrawals before age 65. Did I read properly that for LIF withdrawals the $2,000 tax credit applies to anyone, irrespective of age? Meaning under 65? Should a LIRA be moved to a LIF when the expected minimum withdrawal would be under that threshold? Should LIF withdrawals be recommended for anyone under 65 as a tax strategy? Looking forward to reading your answer. 

—Sylvain Bussiere 

Hi Sylvain, unfortunately your interpretation is not correct. Converting your locked-in retirement account (LIRA) to a life income fund (LIF) before the year you turn 65 does not qualify you for the $2,000 pension tax credit. Even converting your LIF to an annuity doesn’t qualify you for the pension tax credit at age 65.

Having said that, this tax credit is not a big deal for most people, and in some cases, you will be better off not converting an RRSP or LIRA to a RRIF or LIF to qualify for the credit. 

In 2025, the maximum federal tax savings is $290 (for my calculations, read on). There is a little more in savings when you apply the provincial credit, which varies by province. In Ontario, the additional tax saving is $89. That means the total tax savings for everyone in Ontario is $379, assuming they are paying at least $379 in tax. If you can’t use the full credit, you can transfer what you can’t use to your spouse.

Mind the new tax rate

As a reader, Sylvain, you may have read that the maximum federal tax savings is $300 and not the $290 stated above. That was true in previous years, but the lowest federal tax rate was reduced this year from 15% to 14%. The rate didn’t come into effect until the end of June, or halfway through the year. Therefore, for 2025 the lowest federal tax rate and pension tax credit is 14.5%. Next year they will both be 14%. 

The other thing to keep in mind is that claiming the $2,000 pension tax credit is not a way to get $2,000 out of your RRIF/LIF tax-free, something I often hear. Well, okay, it almost is if you are in the lowest tax bracket.  

Doing the math around the pension tax credit

Think about the way the tax credit works. For the federal $2,000 tax credit, a rate of 14.5% is applied and the tax savings is $2,000 x 14.5% = $290. A rate of 5.05% is applied to the $1,762 Ontario credit for a tax savings of $1,762 x 5.05% = $89. The two combined come to a tax savings of $379.

Now think about what happens when you draw $2,000 from a RRIF or LIF. If you are in the lowest tax bracket in Ontario, with a marginal tax rate of 19.55% (14.5% federal + 5.05% provincial), you will pay $2,000 x 19.55% = $391 in tax. When you apply the pension tax credit savings of $379, you end up paying only $12 in tax on the $2,000 withdrawal. If the Ontario pension tax credit was $2,000 rather than $1,762 then it would have been a wash with no tax owing.

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The story is different for a person in the highest tax bracket with a marginal tax rate of 53.53%. A $2,000 RRIF or LIF withdrawal will result in $1,070 in tax before applying the credit, and $681 in tax after the pension tax savings of $379. A person with an income of about $100,000 will pay about $240 in tax after the credit is applied.   

This leads to the next question for the person who is only drawing the $2,000 to get the pension tax credit. Does it make sense to draw the money and reinvest the lesser after-tax amount, or would it be better to leave the full $2,000 in the RRIF or LIF to grow?  This becomes a planning question. What are your spending and gifting plans?

What the pension tax credit is good for

Have I pelted you with enough math, Sylvain? You are right to think about ways to minimize the tax you owe and there are times when you can claim the pension tax credit before the year you turn 65.  

The most familiar way you can claim the pension tax credit before age 65 is when you are receiving income from life annuities from superannuation or employer pension plans. You can also claim the credit if you are under age 65 and are receiving pension payments as the result of the death of a spouse who was eligible for the pension tax credit. In other words, if your spouse is over age 65 and drawing from a RRIF and then dies, you can claim the pension tax credit on that continued income even if you are not yet 65.

Another advantage of the pension tax credit comes with the ability to split pension income. If you have a defined-benefit pension plan you can split your pension income with your spouse before age 65. In this case both of you can claim the pension tax credit, even if you are both under 65. The same is true with RRIF or LIF income after age 65, assuming you are both 65 or older. Instead of claiming a $2,000 pension tax credit, the two of you can each claim the $2,000 credit. Two credits for one pension!

Thanks for your question, Sylvain. Some people automatically convert RRSPs or LIRAs to RRIFs or LIFs to qualify for the pension tax credit without really thinking about it.  

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Read more about retirement finances:

• From RRSP to RRIF—managing your investments in retirement
• What’s more important: your wealth or your legacy?
• Why late-career savers need to be careful with RRSPs
• 3 signs you need to take control of your parents’ finances

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Allan Norman, MSc, CFP, CIMSource