Split your income to save tax
Connor Morris - Mar 15, 2023
There are limited ways to earn income and pay no tax. However, there are many ways to pay less tax.
As an individual, you can save tax by using credits, deductions, exemptions and registered investment accounts. As part of a couple or family, you have opportunities to save tax by transferring money to your spouse or a child who’s in a lower tax bracket.
Here are some of the more common methods of splitting income.
Having the lower-income spouse invest
Due to attribution rules, if the higher-income spouse gives money to the lower-income spouse to invest in a non-registered account, the higher-income spouse is subject to tax on any income and capital gains. However, there’s an easy and effective way to get around this: the primary income earner pays all of the bills and household expenses, enabling the other spouse to make non-registered investments. Now, investment income is taxed at a lower rate. It’s helpful for each spouse to keep a separate bank account and investment account, in case the Canada Revenue Agency (CRA) wants evidence of how the lower-income spouse made the investments.
Gifting funds to family members
If your spouse or children lack the funds to contribute to their Tax-Free Savings Account (TFSA), you can give them the cash as a gift. This way, more family money is invested in a tax-free environment. Depending on a child’s situation, you may also or alternatively wish to gift funds for their First-Home Savings Account (FHSA) or Registered Retirement Savings Plan (RRSP). Quite often, a child who is just starting out builds RRSP contribution room, but rent or mortgage and car payments prevent them from making their full RRSP contribution. In all of these cases, the attribution rules do not apply.
Opening a spousal RRSP
Today’s pension income-splitting rules limit the ways a spousal RRSP can be useful, but benefits do remain. You contribute to a spousal RRSP in your income-earning years, receiving a tax deduction based on your current tax rate. Eventual withdrawals are favourably taxed at the spouse’s lower tax rate in retirement. Find more information in the Income-splitting in retirement section.
Hiring your spouse or child
A business owner can hire their spouse or child, using company income to pay a family member’s salary. The salary qualifies as a tax deduction whether the company is a sole proprietorship or a corporation. Also, the spouse or child benefits tax-wise by receiving an RRSP tax deduction, provided they contribute to their plan. The job must be legitimately required for the business to operate, the pay must be appropriate for the position, and you should issue a T4 slip (and an RL-1 slip in Quebec).
Income-splitting in retirement
One or more of these methods may be relevant to you during your retirement years.
In retirement, you can save tax by having up to 50% of the higher-income spouse’s eligible pension income taxed at the other spouse’s lower tax rate. At age 65 or older, the most common types of pension income eligible for income-splitting are Registered Retirement Income Fund (RRIF) payments, company registered pension plan (RPP) payments and life annuities from a Registered Retirement Savings Plan (RRSP). Note that the spouse receiving any of these payments doesn’t need to be 65 or older.
Some retirees, depending on their retirement income strategy, convert all or a portion of their RRSP to a RRIF before the mandatory age of 71 to take advantage of income-splitting tax savings.
Spousal RRIF payments
A spousal RRSP becomes a spousal RRIF in retirement. While pension income-splitting enables you to allocate up to 50% of eligible pension income to your spouse, taking payments from a spousal RRIF allows you to split more than 50% of pension income.
Also, if you retire before 65, pension income-splitting is mainly limited to company RPP payments (except in Quebec, where residents are unable to split pension income under age 65). However, the lower-income spouse could make spousal RRSP or spousal RRIF withdrawals before 65, providing a source of retirement income that’s taxed at their lower rate.
The Canada Pension Plan (CPP) and Quebec Pension Plan (QPP) allow a couple to save tax by splitting their pension amounts, reducing the higher-income earner’s benefit and increasing that of the lower-income earner. The resulting benefit amounts may not be equal, as the government’s calculation only takes into account the period during which the couple has been living together.