Income Splitting
January 2005
Through carefully planned “Income Splitting,” a couple can reduce their overall tax burden.
We all have to pay tax on the income we earn. Canada has a “progressive” tax system, which means that the higher your income is, the greater the percentage of income you have to pay in tax. For example, an individual in the highest tax bracket in BC paid 43.7 cents of tax on his or her last dollar of income, whereas an individual with an income of $30,000 paid only approximately 21 cents on his or her last dollar of income (the tax rate paid on your final dollar of income, or the next dollar of income that you will earn is usually referred to as a “marginal tax rate”).
If you have a spouse (or partner), it makes financial sense to structure your retirement income so that the least amount of total tax will be paid. For example, a couple with a taxable income of $120,000 will pay less tax if each spouse has an income of $60,000, than they would if the income were $90,000 in one person’s name and $30,000 in the other’s.
There are a number of strategies you can use to “split income” with your spouse:
Spousal RRSPs
You can make a deposit to your spouse’s RRSP. You get the tax deduction for the contribution, but the money is invested in your spouse’s name. The income that is drawn out at your spouse’s retirement will be taxable in his or her hands.
Pension Income Splitting
A Canadian resident can split up to 50% of any income with their spouse that qualifies for the existing pension income tax credit. For those under the age of 65, these payments include annuity payments made under a registered pension plan (RPP) and certain death benefits. For those over the age of 65, the payments include any income derived from their registered plans (RRSP, RPP, RRIF, LIF, PRIF, LRIF, DPSP).
Government Income Entitlements
CPP benefits can be split with your spouse. For example, if you are receiving $800/month and your spouse is receiving $100/month, together you can split the CPP benefits so that you would both receive $450/month ( $800 + $100 = $900/2 = $450 each).
Loans to a Spouse or Partner
If you make an outright gift to your spouse or partner, any income earned from that property or investment will be taxed in your hands; this is called the “attribution rule”). However, you can loan that money to your spouse, and charge the rate of interest prescribed by the Canada Revenue Agency. If your spouse earns investment income exceeding the interest charged on that loan, only the net income is taxable to them.
Downsizing Your Home
Assume that you and your spouse own a home to which you have both contributed, and you sell that home for $600,000, intending to “downsize” to a new $400,000 home. You can structure the transaction so that the surplus capital from the downsizing the home can flow to the individual with the lowest “marginal tax rate”.
Other Strategies
Other strategies include paying your spouse or partner a salary (if you are self-employed), the use of trusts, and focusing family savings in the name of the spouse with the lower marginal tax rate or the lower expected retirement income. Effective Income Splitting can lower your tax bill. Your Rogers Group Financial advisor can assist you in assessing the benefit of various Income Splitting strategies.