Income‑splitting is a trusted tax strategy that helps couples reduce their combined tax liability by shifting income from a higher-income spouse to one taxed at a lower rate. Canada’s progressive tax system means even small shifts in income can translate into big savings—especially for families with a big income gap.
In this guide, we’ll walk through every strategy—retirement income splitting, spousal RRSPs, prescribed-rate loans, spousal business salaries, and more. You’ll find clear examples, simple to follow steps, and explains CRA rules like TOSI. The goal? To help maximize after-tax income legally, ethically, and with full CRA compliance.
1. Understand the Core Idea
Income‑splitting reduces overall household taxes by balancing income so it’s taxed at lower rates.
- Canada allows spouses/common-law partners to split up to 50% of eligible pension income.
- Couples with wide income gaps—like one earning $100k and the other $35k—benefit most by shifting income to the lower-rate spouse .
- It’s not loophole abuse—it’s legal tax planning using the marginal tax bracket structure.
This isn’t just for pensioners: there are methods couples can start today, not just in retirement.
2. Pension Income Splitting: The Retirement Staple
What is it?
Allows splitting up to 50% of “eligible pension income” between spouses via CRA form T1032 .
Eligible Income Types:
- Registered Pension Plan (RPP) payments
- RRIF payments after age 65
- Annuity or non-registered annuity income
Example:
If spouse A has $50,000 and spouse B has $30,000 annual income, splitting $25,000 lowers A to $25k and raises B to $55k. Combined tax paid drops significantly—around $5,200 in savings in Ontario example.
How to do it:
- Both spouses file jointly with T1032 annually .
- Splitting can start even if spouse B is under 65, provided pension income is eligible.
- Returns can be undone in future years—flexibility is strong.
3. Spousal RRSPs – Early Income Splitting
What they are:
Spouse A contributes to Spousal RRSP for Spouse B. When B withdraws, it’s taxed in B’s lower bracket.
Key Advantage:
Works before retirement—RRSP contributions are deducted at higher-income spouse’s rates, while withdrawals taxed at lower-income spouse’s rates .
Watch out:
Attribution rules apply if B withdraws within 3 years of contributions. Planning timing helps avoid that.
4. Prescribed-Rate Spousal Loans – Split Investment Income
Setup:
High-income spouse loans money to the lower-income spouse at CRA’s prescribed rate (e.g., 5% in 2025). Lower‑income spouse invests it.
Why it works:
Income above the loan interest is taxed in the lower-income spouse’s hands.
Example:
Loan $500k at 5% → $25k interest. Spouse invests, earns 8% = $40k. Net $15k taxed in lower bracket—couple saves thousands annually .
Key rules:
Must have legal agreement, charge and pay interest annually by January 30. Watch attribution; only clean if rules followed.
5. Family Business – Reasonable Salaries
For family-run businesses, employing or paying dividends to lower-income spouse/children may shift income legally and reduce overall tax.
Rules:
Payments must match real work done, under CRA TOSI (“Tax on Split Income”) rules.
6. Trusts & Family Loans
Family Trusts:
High-income spouse loans funds to a trust, which invests for beneficiaries (e.g., spouse or child). Income taxed in beneficiaries under low bracket .
Loans must:
Use prescribed interest, legal docs, and annual payment to avoid attribution.
7. CRA Attribution Rules – Understanding Limits
CRA’s attribution rules stop income re-routing to avoid tax. They apply to gifts, early withdrawals, minors, etc.
How to avoid them:
- Use spousal loans with interest
- Stay within rules for RRSP, RRIF, pension splitting
- Follow TOSI for business/family trust income
8. Other Tips for Couples
- Pooling credits: Spouse with fewer credits can claim more, e.g., tuition, medical, charitable credits.
- Spousal tax credit: Claimable if lower-income spouse earns less ($0-$15k range) .
- Strategic RRSP vs. spousal RRSP contributions based on income bracket and retirement planning.
9. Putting It All Together – Your Steps
- Review incomes and tax brackets
- Choose strategy: pension splitting, spousal RRSP, or loans
- Set it up: spousal RRSP contributions, loan documents, pension split file
- Track meticulously for attribution compliance
- Use yearly election forms (T1032) if splitting pension
- Rebalance and revisit annually—adjust with income or tax rule changes
10. When It Mightn’t Work
- Couples with similar income see little gain
- Attribution rules can neutralize simplistic attempts
- In high-interest environments, prescribed-rate loans may not pay off unless investment return is high enough
11. Example Scenarios
Retired Couple, 65+
Spouse A has large RRIF/pension; spouse B has CPP/QPP. They split 50% of RRIF, saving ~$5k/year .
Pre-Retirement Earners
Spouse A contributes $10k to Spousal RRSP. B stays in lower bracket. Outcome: $10k deduction at higher rate + low-tax on withdrawal.
Entrepreneur & Stay-at‑home Spouse
Prescribed spousal loan $200k at 5%, invested for 8% returns. After interest, net income taxed at zero bracket—big savings.
12. Staying Compliant with CRA
- File spousal RRSP, pension-split annual forms
- Prepare spousal loan legal docs and interest payments
- Track and document work done in family businesses
- Respect TOSI restrictions
- Avoid gifts across spouses/minors that trigger attribution
13. Wrap-Up – Save More, Together
Income splitting lets couples with income differences lower their combined tax bill using methods like pension splitting, spousal RRSPs, spousal loans, and proper business salaries—always staying in CRA guidelines.
By choosing the right mix—especially before and during retirement—you’ll hold more of your earned money. Talk to your financial advisor, use these strategies, and watch your household savings grow.
Source : thepumumedia.com