Income Splitting with a Lower-Income Spouse: Strategies and Considerations 🇨🇦
Managing finances effectively is crucial for any couple, and income splitting strategies can be powerful tools for maximizing tax benefits and building wealth. This article explores various strategies for couples where one spouse earns significantly more than the other, addressing the question of whether the higher-income earner can invest in the lower-income spouse's name and the tax implications involved.
Investing in a Lower-Income Spouse's Name:
While it's tempting to leverage the higher tax bracket of the working spouse by investing in the non-working spouse's name, proceed with caution due to potential tax complications. Here's a breakdown of different account types and their implications:
Contributing to a regular RRSP in the non-working spouse's name is only beneficial if they have unused RRSP contribution room, which typically comes from earned income.
If they lack RRSP room, contributing their own funds becomes more strategic. Consider a spousal RRSP:
The working spouse contributes to the non-working spouse's RRSP, claiming a deduction on their tax return.
Future withdrawals are taxable to the non-working spouse, potentially balancing income and reducing combined tax burden.
Caveat: Withdrawals within two years of contribution might trigger "attribution," taxing income to the working spouse.
Contributing to a TFSA in the non-working spouse's name is generally safe. TFSA contribution room accumulates regardless of income, and earnings grow tax-free.
This strategy is particularly valuable as both spouses max out their individual TFSA contributions before moving to non-registered accounts.
Caution advised! Investing the high-income spouse's earnings in a non-registered account under the non-working spouse's name usually leads to income attribution, meaning the income gets taxed on the high-earning spouse's return.
Two exceptions exist:
Prescribed Rate Loan: The working spouse lends money to the non-working spouse at the Canada Revenue Agency (CRA) prescribed rate (currently 5%). The non-working spouse invests the money, deducting the interest paid as a carrying charge to reduce investment income. However, at 5%, profit generation might be difficult.
Second-Generation Income: Even without a prescribed rate loan, the non-working spouse can invest and attribute the initial income to the high-earner. Subsequent reinvestment of that income and its earnings (second-generation income) become taxable to the non-working spouse.
Beyond Tax Implications:
While tax optimization is important, consider these additional factors:
Shared Investment Responsibility: Involving both spouses in the investment process fosters financial knowledge and empowers the non-working spouse in case of future life changes.
Asset Allocation: Building assets in both names diversifies holdings and prepares for potential future needs.
Estate Planning: Strategic income splitting can influence estate taxes and optimize inheritance planning.
The bottom line:
Income splitting with a lower-income spouse offers opportunities for tax savings and wealth building. Carefully consider the different account types, tax implications, and broader financial goals before implementing any strategy. Consulting a financial advisor can provide personalized guidance for your unique situation. Remember, open communication and shared financial responsibility are key to long-term success as a couple.