4 strategies for income splitting with a lower-income spouse

1. Contributing to an RRSP

In the situation you’re asking about, Lynne, if the husband uses his income to contribute to a tax-sheltered account, there may be no tax issues. He can give his wife money to contribute to a registered retirement savings plan (RRSP), for example. But if she does not work, and never has, she probably does not have any RRSP room. RRSP room comes from earned income, like employment or self-employment income.

If she did have RRSP room, though, the husband could give her money to contribute to it without any tax implications. That said, if a person has no income, claiming an RRSP tax deduction would not be beneficial. There would be no tax savings because the person does not pay tax.

2. Contributing to a spousal RRSP

A better option could be if the spouse contributed to a spousal RRSP, Lynne. He can contribute based on his RRSP room and claim a deduction against his taxable income. The account would belong to her, and future withdrawals would be taxable to her. This might help equalize their incomes in retirement and reduce the amount of combined tax payable.

If the RRSP accounts are only in the husband’s name, he can split up to 50% of his withdrawals with his wife, but only if he converts his account to a registered retirement income fund (RRIF), and only once he is 65.

So, having a spousal RRSP in her name could help reduce tax on registered withdrawals prior to 65. One caveat is that if he contributes and she takes withdrawals in the current year or the next two years, there may be attribution of the income back to her husband, meaning it is taxable to him. There is an exemption from the attribution rules if the spousal RRSP is converted to a spousal RRIF, but only when she takes the minimum withdrawal.

3. Contributing to a TFSA

A spouse can contribute to a tax-free savings account (TFSA) in the other spouse’s name, Lynne, without any concerns. TFSA room accumulates regardless of income, and there is no attribution of income between spouses. A couple should generally max out their TFSA accounts before investing in non-registered accounts.

4. Contributing to a non-registered account using a spousal loan

There can be tax issues if the husband invests in a non-registered account in his wife’s name using his income. The resulting investment income would be attributed back to him and taxed on his tax return. The only way to avoid this would be for him to lend money to his wife at the rate prescribed by the Canada Revenue Agency (CRA). It is currently 5%. She could invest the money and deduct the interest paid to him as a carrying charge to reduce the investment income. However, at 5%, it may be tough to make a profit, since she needs to earn more than 5%. The 5% interest she would pay to her husband would also be taxable income that he would report on his tax return. This strategy, at current interest rates, may not make sense.

Even without doing a prescribed rate loan, Lynne, she could invest the money and attribute the income earned back to her husband. It would be taxable to him anyway. But, if she takes that income and then invests it into a separate account, the income earned on that income—so-called second-generation income—would be taxable to her. It may not make a big difference unless she’s investing a lot of money, but it is better than nothing.

Both spouses should get involved

A couple can invest the lower spouse’s income and use the higher spouse’s income to pay the household bills. This does not apply to the situation you’ve described, Lynne, but is worth mentioning for other readers. Beyond the tax implications, there may be a benefit to build assets in both spouse’s names to get them both involved in the investing process. Having one spouse make all the investment decisions ignores the old adage that two heads are better than one. I have seen situations where one spouse makes risky or ill-advised decisions, so having the other spouse involved for checks and balances is beneficial.

Even if the primary investor spouse is making great investment decisions, at least 50% of spouses will someday make their investment and financial decisions on their own. Even if a couple does not divorce, one of them will eventually die, and there will be a survivor tasked with making decisions on their own. Statistically speaking, Lynne, if a husband and wife are the same age, the woman has a longer life expectancy than he. So, there is a benefit to being more directly involved in investing if she is not already.

What’s the best way to split income between spouses?

So, if a husband invests in an RRSP or TFSA account in his wife’s name, there may no tax implications—unless it is a spousal RRSP, and she takes withdrawals in the year he contributes or the subsequent two years. Investing one spouse’s income in a non-registered account will have income attributed back to the higher-income spouse, unless it is through a prescribed rate loan, or the income is second-generation income.

Regardless of how spouses decide to proceed, I encourage partners to be involved in the investment process, if they are not already. It could benefit both spouses in the long run.

Read more from Jason Heath:

• How spouses with joint accounts should claim capital losses
• Planning for retirement with little or no savings to draw on
• Are spousal and child support payments taxable?
• Who to name as executor when family members aren’t an option

About Jason Heath, CFP

Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.

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