If you have a couple in which one spouse has a large income and other has little to none, there are opportunities to income split.
Let’s look at Sarah who makes $200K and John who makes $40K per year:
1. Contributing to an RRSP:
Sarah can give John some of her income to contribute to an RRSP for John and it can save John a bit of money in taxes. You need to be sure that John has some RRSP room.
2. Contributing to a Spousal RRSP:
With a spousal RRSP Sarah has the option of contributing to a spousal RRSP for John. That means she gets the tax deduction now and in the future when the money is withdrawn, it comes out in John’s name.
Does it make sense because in retirement you can income split up to 50% of your RRIF withdrawals, as long as you are over 65?
Yes, it does because you may start withdrawals before 65 and it gives you more flexibility with income splitting.
Remember that it you do a withdrawal from the spousal RRSP in the current or following two years, there may be tax implications for the higher income earning spouse. There is an exemption if the spousal RRSP is converted into a RRIF and they are only taking the minimum withdrawal.
3. Contributing to a TFSA:
Sarah can contribute to John’s TFSA without any tax implications. TFSA contribution room accumulates regardless of employment or not. TIP: Both should max out their TFSA accounts before they invest in nonregistered accounts.
4. Contributing to a non registered account using a spousal loan:
There may be tax issues if the Sarah invests in a non registered account in John’s name. The investment income generated would be 'allocated' back to Sarah and taxed in her name.
One option is for Sarah to lend money to John at the rate prescribed by the CRA (currently 5%). John could invest the money and pay Sarah an interest payment and then deduct the interest payment as a carrying charge to reduce his investment income.
And Sarah would add the interest payment to her income.
In order to make this strategy worthwhile, the rate of return on the investments should be higher than the cost of the interest rate prescribed by CRA.
Let us know if you have any questions.
Sources: https://www.canada.ca/en.html
https://www.moneysense.ca/columns/ask-a-planner/income-splitting-with-a-lower-income-spouse/
