Managing Your Money

When a spousal split spices savings

The federal government is currently encouraging couples to split – income, that is.  Here’s how:  Each quarter, the government’s tax-collecting arm, the Canada Revenue Agency (CRA) establishes a new prescribed rate on taxable benefits and the current rate – a very low 3%, effective from April 1^st to June 30^th, 2004 – offers strong potential for reducing taxes and increasing after-tax investment income through a ‘spousal loan’ income-splitting strategy.

This strategy works when one spouse earns significantly more than the other.  The higher-earning spouse can lend money to his or her partner and, by charging an interest rate that is at least equal to the CRA’s prescribed rate at the time the loan is made, all income and taxable gains on the amounts invested are taxed in the hands of the lower- income spouse.  The lower-income spouse also deducts the interest paid – thus paying tax only on the net amount of investment income. 

The key here is the interest rate.  If the loan is made for less than the prescribed rate (or the current market rate) any resulting income and capital gains are taxed in the hands of the spouse who made the loan – completely negating any tax-saving benefits.  There are a few other rules as well:

·        The lower-income spouse must actually pay the amount of interest owed to the higher-earning spouse within 30 days of each calendar year-end.

·        The ‘lending’ spouse is required to report the interest he or she receives as taxable income.

·        When the return from investment exceeds the prescribed rate, however, there is a gradual shifting of taxable income from the higher-income spouse to the lower-income spouse. 

The benefits are obvious:  Over time, as investment returns continue to exceed the cost of the loan, the more investment income shifts to the lower-income spouse where it grows at a more effective tax rate.  Moreover, even if interest rates rise, the rate of the spousal loan need not be increased as long as the original loan remains in place – this is a ‘locking in’ provision that will continue to deliver income-building benefits for years to come. In fact, the benefits actually increase as interest rates and the market rise – and the larger the loan, the larger the benefit.

The spousal loan strategy is not for everybody, but even if it’s not right for you, there are other income-splitting strategies such as spousal Retirement Savings Plans (RSPs) and income-related investment and bill-paying methods that can reduce the taxes of the higher-earning spouse and put more money in your family’s pocket over time.  A financial advisor  can help you decide which income-splitting strategies work best within your overall financial plan.

This column, written and published by Investors Group Financial Services Inc., is presented as a general source of information only and is not intended as a solicitation to buy or sell investments, nor is it intended to provide professional advice including, without limitation, investment, financial, legal, accounting or tax advice. For more information on this topic or on any other investment or financial matters, please contact your Investors Group Consultant.

[END]