All it takes is a glance at one’ s T4 slip or income tax return to realize that an exorbitant amount of their income goes to the Canada Revenue Agency (CRA) in taxes each and every year. Despite the fact that taxes have become a harsh reality in our lives, all is not lost. There are legitimate strategies of at least reducing the amount of taxes paid: one method is income splitting.
Under our current tax system, the higher one’s income; the greater the percentage of taxes that must be paid to CRA. As a result, a family with 2 people earning $50,000 each would pay far less taxes than a family with one person earning $100,000. With this in mind, it makes sense to spread income among family members in order to lower the overall tax burden. This process is called income splitting. Not surprisingly, CRA also recognizes this fact and as such has significant limitations on income splitting.
One method of income splitting is to arrange a family’s affairs such that the spouse earning a higher income (and paying taxes at a higher rate) also pays as much of the living expenses as possible. This allows the other spouse to save or invest more of their income. Any investment earnings attained are then taxed at the lower marginal tax rate of the spouse that earns less.
Another method of income splitting is via a spousal RRSP. Spousal RRSPs allow the spouse in the higher marginal tax rate to contribute an RRSP in the other spouse’s name. The tax deduction that results is based on the marginal tax rate of the contributor and does not affect the other spouse’s contribution room. The advantage of doing this is that it allows couples to equalize their retirement assets so that when they make withdrawals from their RRSPs, they aren’t taxed as much.
The last method of income splitting that will be covered this month is pension income splitting. As the name suggests, pension income splitting allows for an individual to split their pension income with their spouse. Prior to the 2007 Federal budget, retirees were allowed to split their Canada Pension Plan (CPP) income but this has now been extended to include: all company pension plans, RRSPs, RRIFs, LIFs and guaranteed income annuities (from registered assets). There is no minimum age limit which one can split their company pension plan income or CPP but income splitting with most other sources can only be done after the age of 65.
Income splitting can be a very effective way of reducing a family’s overall tax bill. Additionally, income splitting can often ensure one does not endure reductions in entitlements like Old Age Security, the Age Amount and the British Columbia low income tax reduction. As a result of these potential lost tax revenues, the CRA regulates how and when income splitting can be used. If these rules are not followed correctly, any income generated will simply be attributed back to the individual that was deemed to have earned it. Careful planning and professional advice should be utilized to ensure that these opportunities are maximized and applied appropriately for one’s particular situation.
Troy Peart B.B.A., CFP, CFA can be emailed at firstname.lastname@example.org. Your questions, comments or suggestions for future articles are encouraged.