Tax hacks. Fall in love with these income splitting tips for you and your spouse
Want to make the most of your savings in retirement with your married or common-law spouse? The trick here is not knowing to save, but knowing how to save.
The right account can help you and your spouse max out tax savings and potentially get a higher after-tax combined income after you stop working. Keep in mind, we’re just going to cover the basics here… but if you need help, our financial advisers are just a call away.
Spousal Registered Retirement Savings Plans (RRSPs)
RRSPs are a popular retirement savings vehicle for many Canadians. But can you contribute to your spouse’s account? Sort of.
You can’t contribute to a spouse’s individual RRSP – doing so could lead to potential attribution penalties from the CRA.
But, you can contribute to a Spousal RRSP. And there might be a very good reason to do that.
Don’t think that 50% pension splitting is enough to fully split retirement income for you and your spouse? Is your employment and future retirement income expected to be significantly higher than your spouse’s? Or vice-versa? That’s when a Spousal RRSP could be a good idea.
Zakk and Ella show how income splitting with Spousal RRSPs works
Let’s imagine a nice, happy 30-ish couple, Zakk and Ella. They’re both gainfully employed and doing well for themselves, though their incomes are a little mismatched. After stints tending a bar and running a coffee shop, Zack finally followed his calling two years ago and became an art teacher at Ridgemont High – he earns $60,000.
Meanwhile, Ella has been working continuously for 10 years as a software developer with a growing tech company. After raises most years, she now earns $90,000. Ella is the higher earner. After paying off debt and expenses, she contributes $12,000 to a Spousal RRSP for her husband, Zakk.
Ella deducts the RRSP contribution from her income, which also reduces her personal annual RRSP contribution limit. That would help her get a tax refund, or at least lower the taxes that she pays that year.
In this case, because Zakk is the lower-income spouse, he is the person authorized to withdraw the funds from the RRSP. However, there is a little bit of a complication… if you want to take out that money to use it, here comes the tax man! How do you deal with that?
Spousal attribution rule – How withdrawals from Spousal RRSPs get taxed
Zakk wants to make a withdrawal from the Spousal RRSP. Let’s say that his withdrawal is equal to or less than the contributions Ella made in the year of withdrawal or two preceding calendar years. In that case, the CRA will tax (attribute) the withdrawal amount back to the contributor, Ella. Zakk won’t get taxed, even though (as the lower-income spouse) he is the official holder of the Spousal RRSP.
However, if Zakk wants to make a withdrawal from the Spousal RRSP, but Ella hasn’t made a contribution that year or in the preceding two years, he will be taxed (attributed) on that income.
There are exceptions where the spousal attribution rule wouldn’t apply, such as if Ella died the year the funds were being withdrawn or if Zakk and Ella became non-residents, among others. If you’re using this strategy, best to chat with your financial adviser.
Pension Income Splitting
You can transfer up to 50% of eligible pension income to your spouse. But, there’s a catch. Eligible pension income is treated differently when you’re under 65 than when you’re over 65. Here’s how:
Before 65, pension income splitting is limited to:
- Lifetime annuity payments from a registered pension plan (eg. monthly payments from a private pension)
- Certain death benefits
65 and over, pension income splitting includes:
The same stuff as above, plus payments from:
- Deferred Profit Sharing Program (DPSP)
For most Canadians, this up-to 50% splitting is usually enough to split a couples’ retirement income to maximum efficiency. But maybe one spouse’s income is so high that there is still a gap. Well, there are other strategies…
We can’t forget to look beyond registered savings plans. There are of course non-registered accounts. Here, you can transfer your dividend income to your spouse so they pay the tax at a lower rate.
There are a few conditions, though:
- The dividends must be from a Canadian corporation.
- The transfer must be all or nothing. You can’t just do a portion.
This is not a strategy for most Canadians. It can get complicated because what is recorded on your tax slips may not line up with how you complete your tax return. You’ll want to consult with a professional accountant if you’re looking at doing this.
Splitting your Canada Pension Plan (CPP)
Splitting your CPP is not terribly common (we’ll explain why, below) but here’s an example of how it could work.
Let’s go back to Zakk and Ella, but years later. When Ella took time off to raise their children (even after she went back to work part time), Zakk became the higher income earner. Now that he is retired, he is entitled to about $12,000 a year from CPP. Ella didn’t contribute as much and expects only $6,000 a year from CPP. By sharing CPP credits, Zakk and Ella could lower their total tax bill.
We’re including this example to be comprehensive… but just to be clear – while it might work for Zakk and Ella – this might not be worth the trouble for many Canadians. Your maximum CPP payment might only be around $1,100 a month, each. The tax savings on that income could be meagre. But hey, if you’re on limited income in retirement, every dollar counts.
Tax-Free Savings Account (TFSA)
While this is not specifically an account that couples could use directly for income splitting, a TFSA can be part of anyone’s comprehensive retirement income strategy. And certainly, in cases where there is a big disparity of incomes, it may be better to draw income from this in retirement, instead of paying tax on drawn income from other types of accounts.
You can also gift money to your spouse or common-law partner, who would then put it into their TFSA account. (You can’t ordinarily directly contribute the money into their account – but if it’s coming from a joint bank account, it won’t matter).
There are no tax consequences to withdrawing money from a TFSA… so, make sure it’s at least considered for your overall long-term strategy.
Need help understanding your options for spousal income splitting?
That’s what we’re here for! If you’re a CI Direct Investing client, you get unlimited, no-commission advice from a financial adviser who is looking after your interests. Ask them about how spousal income splitting could help you achieve your financial goals.