Today, we’re going to discuss a powerful yet underused tax-saving strategy: income splitting. Let’s dive in and explore how this strategy can benefit you and your family.
What is Income Splitting?
Income splitting involves redistributing income within the family to reduce overall tax burdens. Specifically, it means shifting income from a higher-income family member to a lower-income family member. This can be done with your children or spouse, but for this example, we’ll focus on spouses.
Benefits of Income Splitting
- Lower Tax Bracket: By shifting income to a lower-income spouse, the family can take advantage of a lower tax bracket.
- Tax Credits: You gain access to available tax credits, which further reduces your tax liability.
- Reduced Tax Payments: Overall, you end up paying less in taxes both now and in retirement.
How Income Splitting Works
- Higher RRSP Contributions: Higher-income spouses earn more RRSP contribution room due to their higher earnings. This often leads to a significant accumulation of funds in their RRSPs.
- Higher Tax Bracket in Retirement: Withdrawing money from a large RRSP in retirement can push you into a higher tax bracket, especially when converting an RRSP into a RIF (Registered Retirement Income Fund).
- Spousal RRSP Contributions: To avoid a higher tax bracket in retirement, the higher-income spouse can make RRSP contributions to a spousal RRSP. These contributions are deductible, providing immediate tax relief.
- Withdrawal Rules: If the lower-income spouse withdraws the money within the first three years, the contributing spouse will be taxed. However, if they wait three years, the withdrawal will be taxed at the recipient spouse’s tax rate, which is typically lower.
Immediate and Long-Term Benefits
- Immediate Tax Deduction: You get an immediate tax deduction for the spousal RRSP contribution.
- Equalized Retirement Income: Over time, this strategy helps to equalize retirement income between spouses, reducing the overall tax liability during retirement.
- Long-Term Tax Savings: By strategically managing RRSP contributions and withdrawals, you can achieve significant tax savings over the long term.
Why Income Splitting is Often Underutilized
Many people contribute to RRSPs without considering the benefits of strategic planning. By employing income splitting, you can ensure that you don’t end up in a higher tax bracket upon retirement. This strategy requires foresight and planning, but the benefits are substantial.
Key Takeaways
- Income splitting helps lower your tax bracket and take advantage of tax credits.
- Spousal RRSP contributions provide immediate tax relief and long-term savings.
- Strategic planning is essential to maximize the benefits of this strategy.
I hope this information was helpful. For personalized advice and to explore how income splitting can work for you, book a meeting for a financial plan or purchase my book, “The Art of Retirement.”
By taking proactive steps now, you can secure a more favourable tax position and a brighter financial future.
