Income splitting is a very appealing idea because it can reduce a couple’s taxes substantially. This strategy is particularly helpful for retired couples who might otherwise have to dip into capital to make ends meet and risk running out of assets when in their 90s or even in their 80s.

The concept of income splitting is to attribute some of the income of a higher tax-bracket spouse to the other spouse. If, for example, Jack is in the top Ontario tax bracket, with a marginal tax rate of 53.53% and his wife, Joan, pays only 20.05%, each $1,000 of Jack’s income that can be attributed to Joan would reduce the joint taxes they have to pay by $334.80 – as long as Joan’s income doesn’t rise enough to push her into the next higher tax bracket. The tax savings would be even greater if Jack can attribute enough of his income to Joan to push himself into a lower tax bracket.

Canadian governments have recognized the benefits of income splitting and implemented measures to allow seniors to split income. But the rules are strict because, otherwise, “everyone would do it,” says Wilmot George, vice president of wealth planning with CI Investments Inc. in Toronto.

The principle behind Canadian taxation is taxing the individual rather than the family or household – unlike in the U.S., where married couples can file a joint tax return. However, Canadian couples are allowed to split pension income, including registered retirement income fund (RRIF) withdrawals and Canada Pension Plan (CPP) benefits. But couples typically can’t split income from non-registered accounts.

The previous federal Conservative government under Stephen Harper extended income splitting to families with children under 18 years old, starting in 2014. But, with the Liberals winning the Oct. 19 election, this provision is scheduled to be eliminated. The Liberals don’t think the measure helps the majority of Canadian families because it mainly benefits families in which one spouse earns a large enough salary to allow the other spouse to stay at home.

Nevertheless, there still are ways in which wealthy or high-income younger Canadians can split income with their spouses – specifically, through prescribed loans or incorporating their business, says Christine Van Cauwenberghe, assistant vice president, tax and estate planning, with Investors Group Inc. in Winnipeg.

Here’s a look at various income-splitting strategies available to Canadians:

Pension splitting. Any Canadian resident receiving qualifying pension income can split up to 50% of that income with a spouse or common-law partner. This is a “paper” transaction done on income tax returns. That is, the higher-income spouse or partner attributes up to half of his or her pension income to the other spouse, but no money changes hands.

Qualifying pension income differs according to the pensioner’s age. Taxpayers of any age can split income with their spouse or partner from registered defined-benefit or defined contribution pension plans. But life annuity or RRIF income can be split only if the registered recipient is 65 or older. However, there is no age requirement for the spouse with whom the income is being split. So, a 65-year-old can split his or her pension income with a 40-year-old spouse.

Other pension income can be split in this way – including income received after the death of a spouse or partner.

Pension splitting usually is done to lower the taxable income of the higher tax-bracket spouse, including reducing or eliminating the clawback of government benefits, such as old-age security (OAS). Pension splitting also can enable a spouse to start claiming the $2,000 pension income tax credit. This credit makes $2,000 of pension income tax-free if the taxpayer is in the lowest tax bracket and reduces the taxes on this income for the partner in the higher tax bracket.

CPP benefits don’t qualify as pension income, although they can be split. (See below.) Other income that doesn’t qualify includes OAS benefits; tax-free foreign pension income; income received from a U.S. individual retirement account; and income from a RRIF transferred to an RRSP, another RRIF or an annuity.

CPP benefits. These can be split by applying to the CPP, which then adjusts the benefits paid so the total entitlement of a couple is split between the spouses. In this case, the splitting goes two ways. That is, the benefits of both spouses are combined and each partner gets half of that total. The splitting of CPP benefits can be changed by making a subsequent application.

Spousal RRSPS. Taxpayers can use RRSP room to make contributions to a spousal RRSP. Before 2007, this was the main way to split retirement income. Because RRIF income now can be split between spouses, there’s less dependence on spousal RRSPs for this purpose. However, these RRSPs are a way to increase the amount of income that can be split because the spousal RRSP is entirely in the name of the spouse, says Van Cauwenberghe.

Note that there is a three-year waiting period before contributions made to a spousal RRSP can withdrawn as income by the spouse. Before the three years are up, withdrawals of those contributions will be taxed in the hands of the contributor.

TFSAS. Anyone can gift money to another for a contribution to a tax-free savings account (TFSA). Thus, a high-income spouse can give money to a lower-income spouse for a contribution to the latter’s TFSA without having to worry about attribution of future income for taxation.

Prescribed loans. These are loans that can be given by one spouse to the other at a low interest rate set by the government (currently 1%). This strategy is a way of lowering the income of high-bracket taxpayers, so that income is taxed at a lower rate in the hands of lower tax-bracket spouses.

If Jack has $180,000 in employment income and investment income of $50,000 from $1 million in investments, while his wife, Joan, has no income, Jack could lend Joan $1 million – in effect, she is taking over his investment portfolio once he has paid any capital gains taxes due. Joan would pay Jack $10,000 in interest on the loan each year, which he would include on his income tax return; Joan would report all the investment income, minus the interest paid. The result would be a lower combined tax bill for the couple.

A major advantage of prescribed loans is that the interest rate charged doesn’t change during the lifespan of the loan, even though the rate for new prescribed loans may change. The prescribed rate of interest is set quarterly.

The biggest risk with prescribed loans, both George and Van Cauwenberghe say, is not paying the annual interest on the loan by Jan. 30 of the following year – that is, 30 days after the end of the applicable tax year. If the interest payment is late, the income generated by the loan will be attributed to Jack and not to Joan.

Note also that prescribed loans really are loans, and should be repaid in the event of a marital breakdown or upon the death of either spouse.

Incorporated businesses. Anyone with his or her own business – including many doctors, lawyers, dentists, consultants, retail store owners and accountants – can incorporate. After incorporation, the business pays expenses – including a salary for the individual who owns the business; earns income; and pays taxes.

Income not paid out can be put in a non-registered corporate account, which can pay dividends to shareholders, which can include the business owner and his or her spouse, business partners and adult children, depending on the type of business. Dividends can vary, depending on the class of share. Thus, if desired, a spouse can receive dividends while the working individual does not get them.

Incorporation is a complicated matter. Advice from a lawyer and an accountant is recommended.

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