Photo by Mark Timberlake on Unsplash

Income tax is one of the largest expenses any retiree has. The Fraser Institute Report indicated that Canadians paid 45% of income as taxes in 2019. 

Your goal in retirement should be to organize your income stream to:

  • reduce the amount of tax you may have to pay 
  • preserve any government tax credits
  • preserve government income plans such as Old Age Security 

The result will be greater spending for you today, and potentially greater wealth for the next generation.

A smart tax strategy to reduce a family’s overall tax burden is to split the income. This means to shift income from a spouse or common-law partner (CLP) who is in a higher tax bracket to one who is in a lower tax bracket. The result is lower overall income tax paid, resulting in increased spending and/or preserving your wealth.

The various income splitting strategies to review are:

  1. Pension Splitting
  2. CPP Sharing
  3. Spousal Loans
  4. Spousal RRIFs
  5. Base the RRIF minimum on the younger spouse’s age
  6. TFSAs
  1. Pension Splitting 

This is a strategy for a spouse/CLP to reduce tax by transferring pension income (for tax purposes) from the higher income earner to the lower-income earner. The transferring spouse/CLP can give up to 50% of their eligible pension income to the receiving spouse/CLP. 

If you are 65 years of age or older, eligible sources for pension income splitting include:

  • a Registered Retirement Income Fund (RRIF) 
  • a Life Income Fund (LIF)
  • a registered pension plan (RPP)
  • an annuity purchased with a Registered Retirement Savings Plan (RRSP). 

It should be noted that the receiving spouse/CLP does not have to be age 65 or older.

If you are under age 65, eligible income is mainly limited to:

  • registered pension plan benefits and certain payments resulting from the death of a former spouse or common-law partner 

Another advantage to pension splitting is both spouses/CLPs would have access to the Pension Income  Amount Credit on the first $2,000 of pension income earned in a year. 

How do you Pension Income Split?

This is done when the income tax returns are filed, using the Joint Election to Split Income form, T1032.

2. Sharing Canada Pension Plan (CPP)

Once you are both 60, you can apply to share your CPP payments with your spouse/CLP. The total amount of pension stays the same, but more CPP income is allocated to the lower-taxed spouse/CLP.  The amount that can be share is based on several factors including:

  • how long you have lived together
  • how long you have contributed to CPP

This is not done on your income tax return; you have to apply to CPP directly. They will do the calculations and adjust the monthly payments.

3. Spousal Loans – Prescribed Rate

You can use a spousal loan to shift income from a higher taxed spouse/CLP to a lower-taxed spouse/CLP to take advantage of their lower marginal tax rate. This is best used for large non-registered investments.

An example might be when one spouse/CLP at retirement receives a lump sum in cash due to selling company shares or a private business.

You can’t give your spouse/CLP the money to invest, and thereby reduce taxes because the CRA has attribution rules which prevent this from happening.

To avoid the attribution rules, you would use a spousal loan. The process would be to:

  • loan money to your spouse/CLP 
  • they would invest the money  
  • each year they have to pay you interest at the prescribed rate, which is set by the CRA  
  • the income earned on the money loaned your spouse/CLP is taxed as theirs
  • you would report the interest paid to you as income  

Assuming the income earned on the loaned money is higher than the interest payment, you are effectively shifting income to a lower tax bracket.  However, to accomplish this there must be:

  • a formal loan document
  • interest must be charged and be at least equal to the CRA’s prescribed rate  
    • this rate is currently 1.0 % and  would last the length of the loan
  • Interest must be paid within 30 days of year-end

The advantage of this strategy is any income earned from the loan money is taxed at a lower tax rate resulting in greater wealth accumulation for couples in retirement.

4. Spousal RRSPs

 A Spousal RRSP occurs when a higher income spouse/CLP contributes to the lower-income spouse/CLP’s RRSPs, who is the annuitant (owner).  

  • The higher income spouse/CLP gets the tax deduction, but the lower-income spouse/CLP is the owner, and in retirement, this can shift income from the higher to the lower income spouse/CLP.  
  • This is often done to make the accumulation of assets about the same for both spouses/CLP prior to retirement.
  • While RRIF income after the age of 65 qualifies for income splitting, prior to age 65 it does not.  Using Spousal RRSPs over time allows you to spread the income over two taxpayers prior to the age of 65 and allows for increased flexibility.
  • Also, if you are over the age of 71, you can still contribute to a spousal RRSP if your spouse/CLP is under the age of 71.

A couple of points to be mindful of:

  • Spousal RRSP contribution room is based on the person making the contribution. 
  • If money is redeemed from the Spousal RRSP within three years of the last contribution, it is taxed to the contributing spouse. However, the minimum RRIF payments are not subject to this attribution rule.

5. Base the RRIF minimum on the younger spouse/CLP’s age

When you convert your RRSP to an RRIF, there is a minimum RRIF payment each year that is based on the age of the RRIF’s annuitant (owner).  This minimum RRIF withdrawal amount % increases each year.

However, if your spouse/CLP is younger than you, you can base the minimum amount on their age, resulting in a lower amount you must withdraw each year.

This can help to: 

  • reduce your current year’s taxation
  • preserve your assets longer
  • and provide more flexibility over time

6. Tax Free Savings Accounts (TFSA)

Prior to and in retirement, any excess cash flow should be redirected into a TFSA.  The reasons are:

  • you can give your spouse/CLP money to invest in their TFSA without the attribution rules applying 
  • there is no tax paid on the income earned in the TFSA, or upon the withdrawal
  • since there is no tax on the income earned in a TFSA or upon withdrawal, income-tested benefits are preserved
  • TFSAs are great as an estate asset because you can name a beneficiary to avoid probate, and no taxes are paid on its transfer 
Summary

Income splitting is a great strategy to reduce your overall tax bill. The strategies need to be reviewed in conjunction with your overall retirement income and cash-flow plan over the long term.

The various Tax planning strategies require a customized approach and need to be reviewed and adjusted each year by your financial advisor and accountant.

For more information, you can refer to Preserving Wealth: The Next Generation – The definitive guide to protecting, investing and transferring wealth by Jack Lumsden, MBA, CFP®

For your FREE Copy CLICK HERE

For your free retirement readiness assessment CLICK HERE

Buy Preserving Wealth  CLICK HERE

Jack Lumsden, MBA CFP®   Financial Advisor, Assante Financial Management Ltd.

This material is provided for general information and is subject to change without notice. Every effort has been made to compile this material from reliable sources however no warranty can be made as to its accuracy or completeness. Before acting on any of the above, please make sure to see me for individual financial advice based on your personal circumstances. The information provided is for illustrative purposes only. Commissions, trailing commissions, management fees and expenses, may all be associated with mutual fund investments. Mutual funds are not guaranteed, their values change frequently, and past performance may not be repeated. Please read the Fund Facts and consult your Assante Advisor before investing.

Insurance products are services provided through Assante Estate and Insurance Services Inc.

Leave a Reply

Your email address will not be published. Required fields are marked *