A smart practice: Splitting income to keep more of your money

November 15, 2018 Julie Seberras

           

To keep your tax rate lower, you need to reduce your taxable income—and your spouse can help

If you're like most physicians, you probably enjoy earning more as your career develops. But you have a dilemma. With Canada's graduated tax system, you face a higher tax rate on the next dollar you earn once you hit designated thresholds.

That's why you may want to consider income splitting as a way to lower your overall household tax liability. This popular strategy lets a higher-income earning spouse shift some of their income to the lower-income spouse.

Here's a simplified example of how the concept works. Suppose your income was $150,000 and your spouse's income was $0 in 2017.

Scenario 1: You assume all income

2017 Income threshold

Tax rate

Your income

Your tax liability

Spouse's income

Spouse's tax liability

Combined tax liability

First $45,282

15.0%

$45,282

$6,792

$0

$0

$6,792

Next $45,281

20.5%

$45,281

$9,282

 

 

$9,282

Next $49,825

26.0%

$49,825

$12,954

 

 

$12,954

Next $59,612

29.0%

$9,612

$2,787

 

 

$2,787

Totals

 

$150,000

$31,816

$0

$0

$31,816

Scenario 2: Income is split 50/50

2017 Income threshold

Tax rate

Your income

Your tax liability

Spouse's income

Spouse's tax liability

Combined tax liability

First $45,282

15.0%

$45,282

$6,792

$45,282

$6,792

$13,584

Next $45,281

20.5%

$29,718

$6,092

$29,718

$6,092

$12,184

Totals

 

$75,000

$12,884

$75,000

$12,884

$25,768

The combined tax you'll have to pay will still be lower than if you had assumed the whole tax burden. The bottom line: if you can level out the amount of taxable income between you and your spouse, you can effectively reduce your overall combined tax liability.

Here's how you can do it, too.

Spousal Registered Retirement Savings Plans

Spousal RRSPs can effectively level taxable income for each spouse in retirement. You'll have to analyze and project both of your expected retirement incomes—CPP, OAS, employer pension plans, as well as any withdrawals from your RRSPs. If you then determine that your spouse's income will be lower in retirement, consider a Spousal RRSP.

The higher-income-earning spouse contributes to the lower-income-earning spouse's RRSP. The higher-income-earning spouse takes the tax deduction, but it also reduces amount they can contribute to their own RRSP. When the money is withdrawn in retirement, the lower-income-earning spouse pays the taxes on it—and that reduces the overall tax liability for the household. Keep in mind, though, that the contributor will be taxed for the money if it's withdrawn in less than 3 years from the time of the contribution.

Spousal loans

Sometimes a higher-income-earning spouse gives money to a lower-income-earning spouse to invest, hoping that any investment growth the couple enjoys will be taxed at a lower rate. Unfortunately, the CRA views this as a way to circumvent taxes. So the government taxes the higher-income earner for the growth regardless of which spouse owns the investment account.

Loaning your spouse the money is the solution. The CRA says your lower-income-earning spouse can invest money that you lend him or her, provided you charge interest and your spouse pays you back at the prescribed rate. The rate at the time the loan is the rate for the life of the loan—and recently, that's been as low as 1-2%. The higher-income earner must still pay tax on the interest. But the reduction in the amount of tax paid on the investment growth typically outweighs the interest costs.

Tax Free Savings Accounts

TFSAs are another great tool. The tax rules allow a higher-income-earning spouse to give the lower-income spouse cash. The lower-income-earning spouse can then contribute this cash to their TFSA—and once the funds are invested, they grow tax fee, can be withdrawn tax free, and will transfer tax free to a beneficiary.

Tax planning is a crucial part of your financial plan. Don't let taxes diminish your hard work.

For more information on how income splitting works, spousal RRSPs, spousal loans or TFSAs, please contact your MD Advisor. He or she can take make recommendations to reduce your tax liabilities by assessing your overall situation and creating a customized plan based on your needs and objectives.

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