Sure, you love your spouse, but there’s another reason to love being in a relationship. It’s called income splitting. I’ll admit the term doesn’t sound romantic, but when you consider how much money it can save you on income tax, it may begin to look that way.
How does it work? It’s based on the way we pay income tax — at an increasingly higher rate the more money we make. Financial expert, Jim Yih, of the Retire Happy blog, explains: “An individual who makes $70,000 per year pays considerably more tax than a couple who earn $35,000 each.” Income splitting is simply the strategy of shifting income from the higher-earning spouse to the lower-earning spouse to save on taxes.
While Canadian couples can’t actually pool their incomes and file a single, joint return as U.S. couples can, there are four easy ways that married or common-law couples in Canada can income split:
1. Spousal RRSPs
This is perfect for relationships where one spouse earns more than the other. As RRSP contributions are based on a percentage of earned income, the spouse earning more can contribute more to an RRSP each year than the spouse earning less. This could result in that spouse having a higher retirement income. However, if the higher-earning spouse was to contribute a portion of his or her allowable annual contribution into a spousal RRSP, it would enable the couple’s retirement savings to build up more equally — and their more evenly distributed retirement income to be taxed at a lower rate.
2. Tax-free savings accounts (TFSAs)
Another fantastic income splitting tool. While there’s no such thing as a spousal TFSA, you’re allowed to give money to your spouse to contribute to a TFSA in his or her own name. You won’t get the same tax deduction as you do with a spousal RRSP, but the income earned on money invested in a TFSA is tax-free. Ensuring you both contribute the maximum annual allowable contribution ($5,500 as of 2013) is another great way to boost your overall savings.
3. Make your spouse a business partner
Do you run an incorporated business? Make your spouse a business partner and share the profits. Of course, he or she needs to do real work or contribute to the business somehow. But, provided this is the case, your spouse’s salary will be deductible from your corporate taxes — thus further reducing your tax bill and leaving money in your pocket.
4. Pension income splitting
Even if you’re not working anymore, you can enjoy the benefits of income splitting. You can elect to allocate up to half of your pension income to your spouse. Again, this can help lessen your tax burden and reduce the overall amount of combined tax you pay as a couple.
To find out more about these income splitting options and whether they may be right for your particular situation, it’s wise to consult a tax professional.
To learn more about the advantages of RRSPs and TFSAs, read: Where to stash your cash: RRSP or TFSA?
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