7 Income Splitting Strategies to Save Your Family HUGE Taxes

Income splitting is a tricky topic. Managing taxes for just yourself is complicated enough—adding a partner makes it even more challenging. But income splitting is an area we spend a lot of time on with our clients, and we’ve seen some amazing results, with some even saving over 6 figures in taxes. 

The Tax Dance: Think of income splitting as a carefully choreographed dance between you and your partner. Both of you need to dance in harmony, but if one partner misses a step, you could risk stumbling into higher taxes. 

Like dancing, you should learn how to do the easier moves first. That’s why I’ll go from the easier strategies to the hardest, starting with…

Strategy 1: Using Your FHSA

I wanted to start with a strategy that nobody else is really talking about, probably because the FHSA is so new. You might be thinking – the FHSA? Isn’t that to save for a home? How can that be used to income split with my partner? Let me explain. 

Who This Strategy is For:
Couples where one partner has unused FHSA contribution room and the other has maxed out their tax-advantaged accounts (RRSP, TFSA, FHSA).

How It Works:
The (FHSA) offers tax-deductible contributions, similar to an RRSP. If one partner (high-income) has maxed out their tax-advantaged accounts, they can gift money to their partner (low-income), who hasn’t used their FHSA. This:

• Prevents the money from being invested in a taxable non-registered account.
• Allows the receiving partner to gain a tax deduction and benefit from tax-free growth.

Example: Using an FHSA for Income Splitting

Scenario:

Meet Ted and Robin. Ted (high-income, 33% tax rate) gifts $8,000 to Robin (low-income, 30% tax rate), who hasn’t contributed to her FHSA.

Why It’s Effective:

• Without FHSA: Ted invests $8,000 in a taxable account and pays $132 annually in taxes on the $400 growth.
• With FHSA: Robin contributes $8,000 to her FHSA, gains a $2,400 tax deduction, and avoids taxes on the $400 growth.
• Total Savings: $2,532 ($132 avoided tax on growth + $2,400 tax deduction), PLUS all future growth is tax-free!
• You can roll it over into an RRSP if you don’t use it for a home

Pros:

• Double Benefit: Ted avoids taxable investment growth, and Robin gains a tax deduction and tax-free growth.
• Tax-Free Withdrawals: When Robin uses the FHSA for a home purchase, the withdrawals are tax-free.
• Flexibility: If Robin doesn’t use the FHSA for a home, she can roll it into her RRSP.

Cons:

• Eligibility: Robin must not have owned a home in the past four years to qualify for an FHSA.
• Ownership Risk: The gifted funds belong to Robin. If the partnership ends, Ted cannot reclaim the contribution.

Strategy 2: Splitting Pension Income (Employer Sponsored)

How It Works:
Pension income splitting allows a higher-income spouse to allocate up to 50% of their eligible pension income to a lower-income spouse. Eligibility for income splitting varies depending on the type of pension income and whether you are under or over age 65. Note that this is for employer-sponsored pension income, NOT CPP, which I’ll cover in strategy 4.

Eligibility Rules for Pension Income Splitting (Before and After Age 65)

There are two main types of employer-sponsored pension income, and that’s DBPP and DCPP, each with its own rules. I’ll break it down for you:

Before Age 65:

1. Defined Benefit Pension Plan (DBPP):
   • Income from a DBPP qualifies for income splitting prior to age 65.
2. Defined Contribution Pension Plan (DCPP):
   • Withdrawals from a DCPP do not qualify for pension income splitting unless it is received as a result of the death of a spouse or common-law partner.
3. Other Pension Income:
   • RRIF withdrawals and LIF (Life Income Fund) withdrawals are generally ineligible before age 65.

After Age 65:

• Both DBPP income and DCPP income are eligible for income splitting.
• Withdrawals from RRIFs and LIFs also become eligible, making it easier for retirees to balance taxable income.

Example: Pension Income Splitting

The way it works is the same for both DBPP and DCPP, here’s how it works:

Scenario:

Let’s say Ted and Robin are retired and enjoying their 60s. Ted brings in $40,000 a year from his pension, taxed at 30%. Robin, on the other hand, has very little income and falls into a much lower tax bracket of 15%. By using pension income splitting, Ted can shift some of his pension income to Robin, so they both pay less tax overall.

Here’s how it plays out:

Why It’s Effective:
Without splitting, Ted pays the full $12,000 in taxes himself because all the income is taxed at his 30% rate. But by splitting $20,000 of that income with Robin, she gets taxed at her much lower 15% rate. Together, they save $3,000 in taxes—a nice bonus just by shuffling the income to the lower bracket.

Note that I created a document about all these income-splitting strategies plus more on my website, so check that out.

Strategy 3: Spousal RRSP Contributions

Spousal RRSPs are a simple yet effective way to share the tax load in retirement. Here’s how they work: the higher-income spouse contributes to an RRSP in the lower-income spouse’s name, getting an immediate tax deduction. When the lower-income spouse withdraws the funds in retirement, they’re taxed at their lower rate.

This makes Spousal RRSPs perfect for balancing retirement incomes, especially if one of you has a workplace pension or there’s a big age gap. It’s like leveling the playing field, so you both get the most out of your savings and pay less tax overall.

Example: Ted and Robin’s Retirement Plan

Scenario:

• Ted’s Income: $120,000 annually, taxed at a 35% rate.
• Robin’s Income: $40,000 annually, taxed at a 20% rate.
• Goal: Equalize their retirement savings since Ted has a pension from work as well, and Robin does not.

Strategy:

• Ted contributes $12,000 to a spousal RRSP in Robin’s name.

Tax Implications:

Why This Works:

• Immediate Deduction: Ted’s contribution lowers his taxable income, saving $4,200 in taxes ($12,000 × 35%).
• Future Tax Efficiency: When Robin withdraws the funds, she pays only $2,400 in taxes at her lower rate (20%).
• Net Savings: Ted and Robin save $1,800 in household taxes by shifting the income to Robin’s lower tax bracket.

Pro Tips:

1. Avoid Early Withdrawals: If Robin withdraws funds within three years of Ted’s contribution, the withdrawn amount will be attributed back to Ted and taxed at his higher rate.
2. Plan for Equal Balances: Aim for equal RRSP balances to avoid uneven retirement incomes and potential tax inefficiencies.
3. Consider Age Differences: If one spouse is significantly younger, plan contributions to ensure balanced withdrawals during retirement.

This is a simplified example, but I go into it in way more detail in my RRSP to RRIF video, so be sure to check that out!

Strategy 4: Splitting CPP Income

For couples receiving Canada Pension Plan (CPP) benefits, income splitting is an easy way to reduce taxes. Here’s the gist: you can shift up to 50% of CPP benefits from the higher-income spouse to the lower-income spouse. This reduces your household tax bill and might even help you avoid the dreaded Old Age Security (OAS) clawback.

Why It Works

Imagine one spouse is taxed at a higher rate while the other is in a lower bracket. By sharing CPP income, you bring balance to the tax equation, paying less overall.

Example: Ted and Robin’s CPP Splitting Plan

Ted receives $12,000 annually in CPP benefits and is taxed at 30%. Robin receives $6,000 in CPP benefits and is taxed at 15%. By splitting Ted’s CPP income, they shift $3,000 to Robin and save on taxes.

Why It’s Useful

• Without Splitting: Ted pays more in taxes because his income falls into a higher tax bracket.
• With Splitting: Shifting $3,000 of CPP income to Robin lowers their overall tax bill by $450.

Strategy 5: Splitting Capital Losses: Turn Losses into Savings

Capital losses can be transferred to your spouse to offset their capital gains using superficial loss rules. This reduces your household tax bill.

How It Works:

1. Sell shares at a loss in a non-registered account.
2. Your spouse buys the same shares within 30 days (before or after your sale).
3. The loss is denied to you but added to your spouse’s adjusted cost base (ACB).
4. Your spouse must hold the shares for 30+ days after purchase.

Example: Ted and Robin’s Tax-Saving Move
Ted has a $4,000 capital loss from selling his investments, while Robin has $15,000 in capital gains. By transferring Ted’s loss using superficial loss rules, Robin’s taxable gains are reduced, saving the couple on taxes.

How It Works:
Ted sells shares and incurs a $4,000 capital loss. Robin purchases the same shares within 30 days, triggering the superficial loss rules. This means Ted’s loss is denied but gets added to Robin’s cost base for the shares. When Robin sells those shares in the future, the $4,000 loss effectively offsets her taxable gains, reducing their household tax bill.

Pro Tip: This strategy works only for non-registered accounts, so keep good records and ensure your spouse holds the shares for at least 30 days after the transfer.

Strategy 6: Prescribed Rate Loans for Spouse or Child

A Prescribed Rate Loan can be a smart way to reduce your family’s overall tax bill, but it’s not without its challenges. Here’s how it works: a high-income spouse or family member lends money to a lower-income spouse or child at the CRA’s prescribed interest rate. The borrower invests the money, and any investment income is taxed at their lower rate instead of the lender’s higher one.

For families with significant income differences and solid investment returns, this strategy can still be worth exploring, but it’s not a one-size-fits-all solution. It comes with risks. 

These include the potential for poor investment returns and the possibility of increased prescribed rates which reduce the effectiveness of this strategy. I would recommend to proceed carefully with professional guidance before attempting this one.

Strategy 7: Family Trust

A family trust in Canada is a legal arrangement where a trustee holds assets for beneficiaries, typically family members. It offers several tax-saving strategies:

1. Income Splitting: Distributing income to beneficiaries in lower tax brackets can reduce the overall family tax burden.
2. Multiplying Capital Gains Exemptions: Allocating capital gains to multiple beneficiaries allows each to utilize their lifetime capital gains exemption, potentially leading to significant tax savings when selling qualified small business shares.
3. Estate Freezing: Transferring future growth of assets to beneficiaries can minimize taxes upon death by capping the value subject to capital gains tax, with subsequent appreciation accruing to beneficiaries.

Combining Income-Splitting Strategies

Income splitting might sound complicated, but the real magic happens when strategies are combined. Think of it as a well-stocked toolbox: each tool serves a purpose, but together, they can build a solid foundation for your financial future.

Here’s an example: A couple could start by contributing to an FHSA for one partner to claim a tax deduction, then use pension splitting to balance incomes in retirement. Add spousal RRSP contributions to create even more tax-deferred savings, further reducing household taxes. Together, these strategies work seamlessly to lower taxes, balance income streams, and help you achieve your goals—whether it’s saving for a home or planning for a stress-free retirement.

At Blueprint Financial, we create personalized income-splitting plans to save you time and reduce taxes. Visit our website to book a free consultation, and don’t forget to like and subscribe for more tips!