From tax saving strategies to joint bank accounts, couples have tools at their disposal to lower their family tax bill, but need to consider where the money comes from especially if one spouse earns more than the other.
A financial planner joined BNN Bloomberg Monday to highlight ways couples can plan their future together by combining household incomes and reaping the rewards of profits on investments while abiding by rules and regulations from the Canada Revenue Agency (CRA).
“Generally, if we have a higher income earner spouse giving money to a lower income earning spouse, it’s because they’re trying to take advantage of that lower tax rate for those capital gains, interest, dividends, any type of investment income. That would really be what they’re trying to achieve by doing that,” said Julie Seberras, head of wealth planning at Manulife Wealth. “Now we have a graduated tax system here in Canada, where we have tax brackets. The higher your income, the higher the rate of tax you’re going to pay.”
She said higher income earners can’t simply shift money to a lower income earning spouse and pay a lower rate of tax. She said the CRA will want to look at the source of the money regardless of the name of the bank account it is under.
Spousal loan taxed at a low rate
An effective way for families to save money is through a spousal loan, whereby the higher-income spouse would transfer money, as a loan, to the lower-income spouse for the purpose of generating investment income which may include interest, dividends, and capital gains, at a lower rate for the family to pay less taxes overall, according to Manulife Investment Management.
“They’re going to loan money to that lower income earning spouse, and it is an actual loan. They need to charge interest on it. They’re going to be charging interest at CRA’s prescribed rate, which right now is three per cent,” said Seberras. “Now, that rate is assessed on a quarterly basis, could be adjusted on a quarterly basis, and it generally follows the patterns of prevailing interest rates.”
“They do have to pay the interest on it. They need to pay that interest within 30 days of year end. They can invest it, and income attribution will not apply.”
The interest rate, payments of interest, documentation and purpose of the loan must be outlined for the loan to be legitimate in the eyes of the CRA. There could, however, be some risks. Market volatility, where investment income is not guaranteed, administrative burden for a proper paper trail and CRA audits on incorrect information can make it more cumbersome than helpful, according to accounting firm Welch LLP.
Seberras said investments need to earn more on the market for the strategy to work. She said it would not make sense in an environment with rising rates.
“When you do that loan, now the income attribution will not apply, but the person who loaned the money needs to take in that interest as income on their income tax return, and the lower income earning spouse can deduct the interest expense on their return,” said Seberras.
3 year wait to withdraw spousal RRSP
Another way families can save money is through a combined Registered Retirement Savings Plan (RRSP). The money, however, needs to stay in the account for three years.
“That higher income earner is going to contribute into an RRSP into the lower income earners name. It is a spousal RRSP. It is in their name,” said Seberras. “The higher income earner is going to take the deduction, which is great, because they get more bang for their buck being in a higher tax bracket. The idea here is that the lower income earner is going to withdraw it at their lower tax rate, paying less tax when they do that withdrawal.”
She said the CRA will want the money to stay in the account for the year it is contributed in and two years after in order for the lower-income earner to not pay as much in taxes. If the money was withdrawn before that time, the higher-income earner will pay taxes on it.
