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Mar 06, 2018

Increasing Your Households After-Tax Income

While there have been many changes announced which may increase a person’s taxes, there is still one legitimate strategy worth considering to reduce taxes – income splitting using a spousal loan.

By CWB McLean & Partners Research Team

While there have been many changes announced with the recent federal budget released on February 27th, 2018 there is still a simple way many of our clients are saving on their yearly taxes – income splitting using a spousal loan. With the Government prescribed rate set to double from 1% to 2%, it may be time to talk to your tax professional about the benefits of a spousal loan.

The concept and mechanics are relatively straight forward, and are most beneficial in a situation where one spouse earns income in a higher marginal tax bracket and the other earns income in a much lower tax bracket. A spousal loan is created whereby the spouse in the higher tax bracket loans money to the spouse in the lower tax bracket (who benefits from earning income and capital gains at a lower rate). Let’s look at the following example.

  • Jane earns income in the highest marginal bracket in Alberta of 48% (2018).
  • Bob is at home taking care of their young family, with no earned income.
  • Jane has amassed non-registered cash and investments of over $1,000,000.
  • Jane initiates a spousal loan to Bob of $1,000,000 of the non-registered money using the current prescribed rate of 1%, secured by a written promissory note.
  • This rate is locked in at 1% for the life of the loan.
  • The interest must be paid regularly and on time to avoid attribution penalties.
  • The money is invested in a well-managed and diversified portfolio, like CWB McLean & Partners Tactical Monthly Income Pool, which offers a 4% income yield and growth potential.
  • Bob pays Jane $10,000 a year in interest income, as an interest expense on the outstanding loan. This is a tax deductible expense to Bob.
  • Jane must claim $10,000 in annual income as a result of interest income paid to her by Bob.
  • All income earned on the $1,000,000 portfolio is taxed in Bob's hands.

In this example we assumed the income on invested assets breakdown as 50% Interest income and 50% eligible dividends.

Table 1:

Table showing taxes paid on invested assets with loan vs without loan

Note: Bob pays zero tax based on the type of income earned and his ability to utilize tax credits. Tax paid from Jane with the loan is interest income.

The loan rate, which is determined by the Government of Canada’s prescribed rate, has been historically low over the past couple of years. As you can see in the chart below, since 2014 the prescribed rate has been 1%, creating an incredibly enticing situation for these types of households where there is a large gap in income levels or liquid assets. However, this prescribed rate from the Government of Canada is set to double as of April 1st, 2018 from 1% to 2%.

Chart showing spousal loan rates from 2002 to 2017

If you are currently in a situation where the marginal tax rates differ substantially between you and your spouse, a spousal loan may be worth inquiring about with your tax professional. Acting before April 1st is important to secure the current 1% loan rate.

Disclaimer: CWB Mclean & Partners are not tax professionals, the information herein is intended for informational purposes only, and is not a solicitation, nor is it to be considered tax advice. We ask that you review the Spousal Loan tax provisions with your accountant or tax professional prior to taking any action.