While Canada’s tax system is beneficial for the country in many ways and a lot more equitable than other tax systems around the world, there’s no denying that tax obligations can put a burden on a family’s finances.
Income splitting is one of these ways and today we’ll be telling you all about it. We’ll go over the basics of income splitting, eligibility criteria, and its benefits.
This will help you make a more informed decision as to whether Income splitting is a viable option for you and your family.
What Is Income Splitting?
Income splitting is a tax-saving strategy that helps working or retired couples lower their tax bill. Under income splitting, the higher-earning partner will transfer a part of their income to the lower-earning partner to the extent that both incomes end up in similar tax brackets.
This strategy is even more effective when the difference between the income of both partners is significant.
For example, if one partner earns $120,000 a year and the other partner makes about $50,000 a year, the higher-earning partner can split that income difference, which amounts to $70,000, with the lower-earning partner.
This means that they would each show a taxable income of $85,000. This is referred to as income splitting.
How Is Income Splitting Beneficial For Canadian Couples?
Why is transferring income to your lower-earning partner advantageous?
Well, as Canada has a progressive tax system, the more money or income you generate the more tax you have to pay. Not just in total amount but also percentage-wise.
So, if you take our earlier example, the partner earning $50,000 will be subject to 15% federal tax but the partner earning $120,000 will be subject to 15% tax on the first $53,358 of taxable income, then 20.5% on income over $53,358 to $106,717, and 26% on income over $106,717 to $120,000.
By using income splitting, however, each partner will show an income of $85,000 where the first $53,358 will be taxed at 15% and the rest at 20.5%.
By transferring a part of their income to the lower-earning partner the higher-earning partner will automatically fall under a lower tax bracket, bringing down the total tax bill; significantly in some cases.
This strategy becomes even more effective during retirement as splitting retirement income with your spouse can significantly reduce the total tax bill, leaving a couple with more money to spend as they live out their golden years.
To learn more it is important to consult with a financial advisor or wealth management expert as they can best guide you on what strategies are feasible given your current financial circumstances.
Also, while there are tax benefits to income splitting, you should know that not all types of income, or couples, are eligible to enjoy these benefits.
Who is Eligible for Income Splitting in Canada?
As for WHO is eligible, the person receiving the split income needs to be at least 65 years old, and both partners must be residing in Canada and living together, under a genuine and sincere relationship, for the year in which the income split is being reported.
One partner must also earn significantly more money than the other so that they fall in different tax brackets under the progressive tax system.
It’s possible to split income before the age of 65, but you would be limited to very specific investments and incomes, like a Registered Pension Plan or a spousal loan. However, in most cases, it is a lot more difficult to split income and enjoy tax benefits if you’re under the age of 65.
As for WHAT is eligible, tax benefits from income splitting are limited to very specific types of income. Some of these include life annuity incomes or income from an RRSP or RRIF.
Also, when you think that you need to be 65 years old to enjoy the tax benefits of income splitting, it would be safe to assume that retirement incomes like the Canada Pension Plan or Old Age Security can also be split. However, you’d be wrong! Government benefits like these are not qualified for income splitting under the Canadian tax framework.
Top Strategies For Income Splitting
Income splitting isn’t just as simple as taking some money from the higher-earning partner and putting it into the bank account of the lower-earning partner. A lot of regulations of the Canadian Revenue Agency (CRA) apply to these matters, and you need to report income sources, even those from savings and side investments, in a lot of detail.
While it might be wise to speak to a wealth management expert to get more details, we will be discussing some strategies that you can employ that satisfy regulatory requirements and give you the most tax benefit.
Make Contributions To Your Spouse’s Registered Retirement Savings Plan
As the higher-earning partner, you could make contributions to your spouse’s RRSP. The amount you contribute has to stay in the RRSP for at least 3 years, and when withdrawn, it has to be reported on your tax return.
If your spouse doesn’t have an RRSP, then it’s pretty easy to set up. You get long-term stability with an RRSP and there are other tax advantages attached to them as well.
Another great way of getting further tax relief is to convert the RRSP to a registered retirement income fund when your spouse retires.
Splitting Pension Income
If you and your spouse are both above 65, retired, and have an eligible pension income, then you have the option of splitting up to half your pension income with your spouse. In the event both of your incomes are eligible, then you’ll need to state who receives the money from whom.
There is also a specific CRA form you need to fill out, ‘T1032 - Joint Election to Split Pension Income’, which you’ll submit with your annual tax return.
Just so you know, some of the pension incomes that are not eligible for income splitting are government benefits such as The Canada Pension Plan, Old Age Security benefits, retiring allowances, foreign pension incomes, and incomes reported on T4RSP slips.
Can You Benefit From Income Splitting? - Consult With An Expert!
While there is no doubt that income splitting can benefit families by lowering their tax burden, there are some drawbacks to consider. Firstly, there are eligibility requirements that restrict who can benefit and the methods through which they can benefit.
Secondly, there is some paperwork and diligence required. You’ll need to be mindful about reporting and filing annual returns to ensure you get the most benefit.
It does get easier if you speak to financial advisors who can guide you in great detail on all the ins and outs of income splitting and its tax implications.
At Eastport Financial Group our expert advisors are highly-trained and experienced in such matters and can offer you guidance on all financial matters.
To learn more call us at 902-474-533 or visit one of our office locations in Halifax, Mahone Bay, and Toronto. You can also email us at info@eastportfinancial.com
