How to use income splitting to keep more of your money

No one wants to pay more taxes than they have to. As your career develops and you earn more, you’ll face higher tax rates because of Canada’s graduated tax system.

One way to lower your household’s tax liability is to consider income splitting. This works best if one spouse earns significantly more than the other spouse does. Income splitting lets the higher-income spouse shift some of their income to the lower-income spouse (whether they are married or common-law). A significantly lower-income spouse will be in a lower income tax bracket.

An example of income splitting

In the first scenario, the $150,000 income goes to you alone. In the second scenario, the same income is split between you and your spouse.

Scenario 1

Scenario 2

Assumption: The after-tax incomes for the above scenarios were calculated based on the 2022 tax rates using the province of Ontario.

With income splitting, your total taxes are $14,226 less on an income of $150,000. The bottom line: if you earn more than your spouse does, shifting some of your income to them can reduce your combined tax liability.

Four ways to split income

1. Electing to split pension income

If you have pension income, you and your spouse can elect — when filing your personal income tax returns — to split up to 50% of your pension income. This includes income from a company pension plan, a life annuity, a registered retirement savings plan (RRSP) and a registered retirement income fund (RRIF). Note: you must be over age 65 to make RRIF withdrawals. 

It’s as simple as completing the Joint Election to Split Pension Income form when filing both of your tax returns. This allows the higher-income earner to deduct some of their pension income from their own, higher tax bracket income to include it in their spouse’s lower tax bracket income. 

2. A spousal registered retirement savings plan

A spousal RRSP can effectively level out taxable income between spouses in retirement. You’ll have to think ahead and try to project your expected retirement income — from the Canada Pension Plan/Quebec Pension Plan, Old Age Security, employer pension plans and withdrawals from your RRSPs/RRIFs. If you determine that one spouse’s retirement income will be significantly lower than the other’s, consider a spousal RRSP.

Here’s how it works: the higher-income spouse contributes to the lower-income spouse’s RRSP and takes the tax deduction. Note that these contributions reduce the amount the higher-income earner can contribute to their own RRSP. When the lower-income spouse withdraws the money in retirement, they pay the taxes on it — and that reduces the tax liability for the household. Be aware, though, that the contributor will be taxed if the money is withdrawn in less than three years from the time of the contribution.

To learn more, see our article “Should you contribute to a spousal RRSP?”

3. A spousal loan

It can be tempting for a higher-income spouse to give money to their lower-income partner to invest, hoping that any investment growth the couple enjoys will be taxed at a lower rate. The Canada Revenue Agency (CRA) views this, however, as a way to circumvent taxes. In this case, the government would tax the higher-income earner, even though their spouse owns the investment account.

Lending the money to the lower-income spouse creates a different situation. The CRA says the lower-income spouse can invest money that the higher-income spouse lends them, provided that interest is charged on the loan at the CRA’s prescribed rate and that the loan is repaid.

The rate that’s set at the time of the loan is the rate for the life of the loan, and recently, that rate has been 4%. The interest must be paid to the lender by January 30 of the following year, every year (the interest can’t simply be added to the value of the loan) and the higher-income earner must pay tax on the interest from the loan. However, the reduction in the amount of tax paid on the investment growth typically outweighs the income tax paid on the interest.

4. Tax-free savings accounts

Tax-free savings accounts (TFSAs) are another great tool. The tax rules allow a higher-income spouse to give the lower-income spouse cash to contribute to their TFSA. (You cannot contribute directly to your spouse’s TFSA.)

There are no tax deductions for contributions to a TFSA, but once the funds are invested, they grow tax-free, can be withdrawn tax-free, and will transfer tax-free to a beneficiary. Because the investment income earned in a TFSA is tax-free, the attribution of income back to the giver doesn’t apply, unlike the case with spousal loans.

How MD can help with tax planning

Tax planning is a crucial part of your financial plan. Don’t let taxes diminish the return you get for your hard work. For more information on how income splitting works or on a spousal RRSP, a spousal loan or TFSAs, please contact your MD Advisor: they can recommend ways to reduce your tax liabilities. They’ll start by assessing your overall situation, and then create a customized plan based on your needs and objectives.

* MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec), or an MD Private Investment Counsel Portfolio Manager.

The above information should not be construed as offering specific financial, investment, foreign or domestic taxation, legal, accounting or similar professional advice nor is it intended to replace the advice of independent tax, accounting or legal professionals.