Different Ways to Split Income With A Spouse
Fee-for-service financial planner and founder of PlanEasy.ca
Splitting income is an interesting and potentially very beneficial tax planning opportunity for couples. Because we’re taxed individually on our income it can be advantageous to split income and reduce the overall income tax bill for the household.
The ultimate goal of income splitting is to perfectly split the household income and the corresponding tax bill. Splitting income 50/50 is the ideal way to minimize the household’s income tax. However, the CRA doesn’t like this, and there are lots of rules in place to prevent income splitting in certain situations.
Income attribution is what happens when you split income that you shouldn’t have. Even if you didn’t earn that income it can still be attributed back to you and needs to be captured on your annual tax return.
For example, if the higher-income spouse gives the lower income spouse $10,000 to invest, any income earned on that investment is attributed back to the higher income spouse, even if it doesn’t get paid into their account and/or they don’t receive a T5/T3 tax slip.
Income attribution is a huge deal. It requires people to properly report their income. The onus is on the couple to split their income properly. If a household doesn’t properly split their income, and they fail to report income attribution, it can come back later in the form of an audit and/or fines & penalties.
The goal with income splitting is to avoid these attribution rules and legally split income to the extent it’s possible.
Income splitting isn’t for everyone but many people can benefit from at least some basic income splitting.
Gifting Money To A Spouse For TFSA Contributions
One easy way for couples to split income is to gift money to the lower-income spouse for TFSA contributions. This isn’t something that you can do with RRSP contributions, which have to come from your own earned income, but it’s a great opportunity for TFSAs.
For couples where there is one high-income earner and one low-income partner this can allow for additional tax sheltering each year.
Just make sure to do it “by the book”. The best practice is to gift money to your spouse and have them make the TFSA contribution themselves from their own separate bank account. Anything else is potentially offside with the CRA.
Spousal Loan For Non-Registered Investments
Another great way to split income is to set up a spousal loan for non-registered investments. This is only an opportunity if you’ve already maximized available tax sheltered space. By setting up a spousal loan you can avoid income attribution rules. The lower income spouse can make money on these investments and get taxed at a lower rate. They just need to make regular interest payments to the higher income spouse for the loan.
Best practice is to have a lawyer help set up the loan agreement. The interest rate on the loan has to be at least the minimum prescribed rate (currently 2%) and interest payments have to be made by January 30th each year.
Having Higher Income Spouse Pay All The Bills
Another way to free up money for the lower-Income spouse to invest in a non-registered account is to have the higher income spouse pay most (possibly all) of the household expenses. This frees up cash flow for the lower income spouse to invest. Because these investments come from their own income there is no concern with income attribution.
It seems like semantics, but this avoids income attribution rules and doesn’t require a spousal loan to be set up.
Focus On 2nd Generation Income
The CRA income attribution rules affect first generation income but not second generation income. This means that interest earned on interest is not attributed back to the higher income spouse even when they provided the funds for the initial investment.
For example, any reinvested dividends will now start creating income for the lower income spouse. This “2nd generation income” won’t get attributed back to the higher income spouse.
Pension Income After Age 55
For early retirees there aren’t many options to split income, but there are a few types of income that the government will let you share with a spouse. One of those types of income is pension income from a defined benefit plan.
Defined benefit pension income and be split with a spouse after age 55. When there is a large disparity in retirement income this can result in a very significant amount of tax savings for early retirees.
Many Types of Income After Age 65
After age 65 there many additional types of income that retirees can split. Most notable is RRIF income.
Retirees who are over the age of 65, and who decide to convert their RRSP to a RRIF, can now benefit from income splitting as well. This income splitting happens as you file taxes. Up to 50% of the RRIF income can be split with a lower income spouse and moved to their tax return.
This type of income splitting can significantly reduce the tax bill when spouses have dramatically different amounts of registered savings (that being said, using a spousal RRSP to balance registered savings between spouses before retirement is still a best practice).
CPP Pension Sharing
Another less talked about (and less necessary) form of income splitting for retirees is called CPP pension sharing.
When a couple has unequal CPP benefits this can help reallocate some of the CPP income. This form of income splitting is physical, meaning that CPP is recalculated and new amounts get paid to each spouse that are a little more equal. The amount that can be split depends on how long partners have been married relative to how long they’ve contributed to CPP.
With other (easier) income splitting options available to those over 65 this method of income splitting is a little less useful.
Disclaimer: Always seek professional advice when it comes to tax planning. This post is for educational purposes only. Please consult with an accountant or unbiased advice-only financial planner for potential tax planning opportunities for your household.
Financial planner, personal finance geek and founder of PlanEasy.