7 Income Splitting Strategies For Families
Our Canadian tax system has graduated tax brackets that result in people with earnings in higher tax brackets paying a greater amount of tax.
Income splitting is a tax planning technique designed to shift income from a high-income earning taxpayer to a family member at a lower tax rate.
The Income Tax Act has clear rules about income splitting. Here are some strategies that may reduce your overall family tax bill.
7 Income Splitting Strategies For Families
1) Lend money to your spouse
Adam lends his wife Amy $200,000 at the prescribed government rate of 1% secured by a written promissory note. Amy invests the money in dividend paying stocks with a current yield of 4%.
Before January 30th each year she pays Adam the interest amount of $2000. The $8000 investment return is taxed at Amy’s lower rate and Adam includes the interest on his tax return.
2) Gift money to your spouse
Barney doesn’t want to set up a loan to his wife, Betty so he gives her $200,000 to invest. The annual rate of return is 4%.
In this case, Barney must declare the investment income as it is attributable to him. However, the second-generation income (income on income) is claimed by Betty. To simplify their bookkeeping, Betty moves this earned income into a separate account.
3) Pay all the household expenses
Carter pays all the family expenses with his higher earnings. His spouse, Cindy, earns a much lower income because she works only part-time.
She invests her income and the returns on these investments are taxed at her lower rate.
4) Spousal RRSP
Spousal RRSPs can equalize income in retirement. Dylan is the sole earner in his family and, on retirement, he will enjoy the proceeds of his defined benefit pension.
He contributes to a Spousal RRSP to receive the tax deduction now, and when his wife Doreen ultimately withdraws the funds (keeping in mind the 3-year attribution period), the money will be taxed in her hands.
5) Invest in a minor child’s name
Edward and Ellen have opened “in trust” accounts for each of their grandchildren – Emma, Elijah and Eloise.
They have chosen investments with good growth potential as capital gains will be taxed in the children’s hands, but interest and dividends will be attributable to the grandparents. The children’s parents, Ernest and Emily, are also investing the child tax benefit in their children’s names. There are no attribution rules with these funds.
6) Splitting CPP benefits
You must submit an application to share your CPP pension. Both spouses must be age 60 or older.
Gordon receives $13,000 in CPP benefits annually. His wife Geraldine has never paid into the plan. Gordon applies to split his payments with his wife and they each receive $7,500.
Harvey is entitled to $10,000 in annual CPP benefits and his spouse Henrietta receives $4,000. They apply to split the benefits and each receives $7,000.
The split is determined by CPP, not the applicant. In most cases, but not always, it is a 50/50 split. The portion shared is based on the number of months lived together.
7) Pension income splitting
Ingrid receives retirement benefits from her company’s registered pension plan. When she completes her income tax return she can allocate up to half the amount to her spouse Ian who has no pension plan.
If you are 65 or older, RRSP and RRIF withdrawals can also be split up to 50%.
It doesn’t have to be the same amount each year or the same percentage. The extent to which pension income splitting will be beneficial will depend on the marginal tax bracket of each spouse, as well as the amount of qualifying income that can be split. You can choose the best solution for your own situation.
Both spouses will be able to claim the pension income credit.
Can we also split CPP amount even if one spouse did not work his life due to physical problems which are not declared disability but making the spouse unable to work.
Hi Glen. Yes, you can split CPP benefits even if your spouse has never paid into the plan. Your spouse must be age 60 or older.
I didn’t know about the CPP splitting, thank you.
When the time comes, it will be interesting to see if it makes sense for me to claim CPP early to benefit from the tax savings on splitting or wait and receive a larger inflation adjusted monthly payment.
Just what I need, another factor to consider in my CPP calculations 😉
Besos Sarah.
Ha! Ha! Sarah. I know. So many options and variables to consider before making a decision.
A very timely article. I have actually been working on something similar aimed at my colleagues (doctors and other high income earners) with the new rules to stop income splitting within Professional Corporations coming into affect with the New Year. Not being one to put all of my eggs in one basket subject to political whim I have used many of your suggestions for years despite having a corporation. Glad I did. I haven’t looked into number 5 because I didn’t realize it – thanks for the tip! I don’t have the money to do that yet, but maybe someday.
One other strategy is to make sure you use TFSAs. The higher earning spouse should max out their lower income spouse’s TFSA for them. Since it is tax free, attribution doesn’t matter.
You could do the same with your over 18 kids that have room if they don’t have the income to do it. The advantage for them is to grow their contribution room with the growth investment earnings. You could either let them keep the money forever or agree to get it back when they are well enough established to contribute on their own and pay it back (not sure if I’d want that social complexity or not). One caution, if your adult children are trying to get OSAP (free tuition plus loans in Ontario) – that TFSA counts as an asset and would reduce their grants. That would not affect those with family incomes over $170K/yr who don’t get the grants anyway. Not a bad problem to have though.
@Loonie Doctor: Thanks for your comments. I didn’t mention contributing to a spouse’s TFSA or a child’s RESP here because it didn’t exactly fit my theme. Nevertheless, both are excellent strategies to consider.
Hi Marie,
Interesting article but I thought income splitting was no longer allowed? Also, if one spouse is not working how can a spousal RRSP be set up? I was under the assumption one had to be working to have RRSP contribution room.
Thanks!
Hi Gert. What you’re referring to is income splitting within small businesses and Professional Corporations which the feds are saying is a tax loophole (?).
Spousal RRSPs are often set up especially when one spouse is not working. The contributor (higher or sole income earner) uses his or her own RRSP contribution room and the funds in the plan belong to the spouse (annuitant).
Actually, the TFSA can/could be a great way to take a tax free income.
Example: A couple sells their home and decides to draw an income from the sale proceeds to pay part or all of the rent. If they have room, they could take advantage of $100000 aprox btwn them available at the start of 2018? The deposit hopefully grows, but the income is tax free. 5 years from now they have added $55,000 if they choose to the ongoing income withdrawal. Take advantage before rule is changed.
In the theme of income splitting, a neat way to split income from a higher income to low income spouse is for the high income earner to contribute to a Spousal RRSP just like suggested in this article. Then, use the tax refund to top up their spouse’s TFSA. If in the highest marginal bracket, you could top up both TFSAs with the refund. Using government sanctioned income splitting to fund more income splitting. Makes me smile every time I say it.
Love this: “Using government sanctioned income splitting to fund more income splitting. ”
I too mostly contribute to the spousal RRSP and use the tax refund to increase her TFSA contribution.