Income splitting is a proven strategy to reduce your tax burden in Canada.
Canadians indeed pay the second-highest personal income taxes among other advanced economies globally. Organization for Economic Co-operation and Development (OECD) member countries have ranked Canada among the highest taxing nations.
While everyone realizes that taxes are necessary for keeping infrastructure and public services functioning, a large tax payment can strain your budget and become a burden, especially if you are not prepared.
Since Canada has a graduated income tax system, everyone is looking for ways to reduce their overall family’s tax burden as no one wants to pay more taxes than they have to. One way you can lower your household’s tax bill is to consider income splitting in Canada.
So, if you earn significantly more than your spouse or common-law partner, income splitting is perfect for you. It lets you (the higher-income spouse) shift some of your income to your spouse who earns a lower income as your lower-income spouse will be in a lower income tax bracket.
There are plenty of ways to redistribute assets and earnings between higher-and lower-income earners to drive down the family’s overall tax bill. This article talks about five strategic ways to use income splitting in Canada to reduce your tax bill.
What is Income Splitting?
Income splitting in Canada is the practice of shifting income from a higher-earning spouse to a lower-earning spouse to reduce the overall tax paid by the family. Income splitting strategically reduces tax on the split income.
Every Canadian family is allowed to split up to 50% of their eligible pension income with their spouse. By having the income taxed from your spouse with the lower income, you can reduce the overall tax paid by the family.
5 Income Splitting Canada Strategies to Reduce Your Tax Burden
We have outlined five strategic ways how you can use income splitting to reduce your family’s tax burden.
1. Split Your Pension Income with your Spouse
Pension income splitting is a perfect fit for spouses or common-law partners who receive eligible pension income.
It provides you with the opportunity to reduce your overall taxes by moving income from a higher-income spouse to a spouse who is in a lower tax bracket.
If you’re 65 or older, you and your spouse or common-law partner can split up to 50% of your qualified pension income.
For example, if you are the higher income spouse and you have about $120,000 in your eligible pension income, and your spouse earns about $32,000 in their retirement income, you can shift about $42,000 of your pension income to your spouse to reduce your overall family tax burden.
To do this, you and your spouse must make a joint election on your income tax returns to be able to split your pension income with your spouse. When submitting your tax returns, you must complete the Joint Election to Split Pension Income form.
However, you should know that not all income can be split. The following are eligible incomes that can be split:
- Lifetime annuity payments from an RPP, RRSP, DPSP, and Retirement Compensation Arrangement (RCA)
- Payments from an RRIF, LIF, LRIF, PRIF
- Taxable foreign pensions
- Interest from a Guaranteed Interest Annuity (GIA)
- Interest from a non-Registered Life Annuity
The following are incomes that cannot be split:
- Canada Pension Plan (CPP), Quebec Pension Plan (QPP)
- Old age security (OAS), Guaranteed income supplement (GIS)
- Any foreign source pension income that is tax-free in Canada because of a tax treaty that entitles you to claim a deduction
- Income from a US IRA
Aside from saving part of your pension income at a lower tax rate, splitting pension income may have other benefits. It can affect credits and benefits solely based on one spouse’s or partner’s net income.
2. Lend Money to Your Spouse
If you earn significantly higher than your spouse, you can loan money to your spouse at the Canada Revenue Agency (CRA) prescribed rate.
When you loan to your spouse, they invest the loaned money to earn a higher return than the CRA’s prescribed rate while also saving tax for the family. The prescribed rate set quarterly by the Canada Revenue Agency is now 1%.
So you give money to your spouse since they are at a lower tax rate than you, your partner invests the funds, and any dividends are then taxed at the lower tax bracket of your spouse. And suppose your investment expects more significant returns than the required rate; it will be an excellent strategy to reduce your taxable income.
3. Make Contributions to a Spousal RRSP
Suppose your spouse makes less money than you do. There’s a strong possibility they’ll have less income in retirement. A spousal Registered Retirement Saving Plan (RRSP) can be beneficial for income splitting.
You can use your RRSP contribution room to top up your lower-earning spouse’s RRSP and claim the tax deduction. However, this strategy reduces the amount you can contribute to your RRSP.
When your spouse withdraws money in retirement, they will pay lesser taxes on it, which will reduce the family’s tax burden.
4. Max Out Your TFSAs
Tax-free savings accounts (TFSA) are another excellent tool for income splitting. There are no tax deductions for a TFSA account, and when you invest, the funds grow tax-free. You can withdraw it tax-free and transfer the funds tax-free.
If you earn higher than your spouse, you can also give them cash to contribute to their TFSA as you can directly contribute to your spouse’s TFSA.
TFSA has more flexibility than an RRSP because you can take the money out anytime, and in addition, the compound interest grows money over time. It can significantly impact your family’s fortune.
5. Pay Dividends to Your Spouse and Children
Set up your incorporated business and include your spouse and children as stakeholders. This strategy gives you a lot of flexibility as the dividends paid, and the receivers of those dividends can vary from year to year.
You can distribute dividends to your family members to reduce your tax burden.
Advantages of Income Splitting
Pension income splitting is particularly beneficial to couples in different income levels and tax brackets. If you are a high income earner and in a higher tax bracket, you would be benefitting from income splitting.
Though you might not be working after retirement, you might still have large income coming in from your investments accounts, income splitting can help bring your tax obligation down to the minimum.
Income splitting might be unnecessary if you and your spouse or common-law partner are in the same tax bracket during retirement.
Final Thoughts on Income Splitting Canada
Reducing your family’s tax burden puts more money in your pockets and allows you to achieve your family goals more quickly.
I believe you can reduce your taxes via effective tax planning with these strategies. If you have further questions about these strategies, please contact me.
I can integrate effective investment tax planning with your family’s financial planning and ensure that you can achieve your family’s goals as efficiently as possible.
FAQs on Income Splitting Canada
Who is eligible for income splitting in Canada?
What income can be split between spouses?
Lifetime annuity payments from an RPP, RRSP, DPSP, and Retirement Compensation Arrangement (RCA), Payments from an RRIF, LIF, LRIF, PRIF, Taxable foreign pensions. Interest from a Guaranteed Interest Annuity (GIA) and Interest from a non-Registered Life Annuity.
Is pension splitting a good thing?
Is income splitting allowed in Canada?
Yes, Canada allows income splitting. Pension income splitting will enable retirees to contribute up to 50% of their qualified pension income to their spouse or common-law partner. However, to split pension income, you must meet specific criteria.
What are income splitting rules in Canada?
Canada’s income splitting rule require that the couple looking to split their income lived together in Canada within the tax year for which they are splitting income.
What is the benefit of splitting pension income?
How does income splitting work in Canada?
Hi, I'm Adeola Adegoke. I am a licensed Insurance Broker in Manitoba, and I hold a master’s degree in Mathematical Sciences (with a major in Financial Modeling) from the African Institute for Mathematical Sciences (AIMS), Tanzania.
Also, I have a second master's degree in Statistics from the University of Regina, and I am currently pursuing my Ph.D. in Statistics at the University of Manitoba.
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