The main objective of income splitting is to evenly distribute the income between a higher and lower taxed spouse to minimize your household tax bill. Canadian Controlled Private Corporations (CCPCs or commonly called professional corporations) have allowed adult children and parents of the owner to also be non-voting shareholders, giving a very wide interpretation of household, and many potentially lower taxed members to split their income with by using dividends. As described in my background post about income splitting, that has ended.
The term “income sprinkling”, as popularized by Wild Bill’s Fair Share World Fair, was probably meant to be inflammatory. However, there is some accuracy to it. It does not makes sense to have all of the income flow to one or two people like a high pressure hose, but rather to spread it out in smaller amounts to keep as many in the group in as low a marginal tax bracket as possible. The new dividend rules penalizing dividends turn down the water pressure (you can’t move as large amounts of income as quickly and easily), but it does not stop it completely. That is ok. We can still water our financial gardens without the firehose.
Income sprinkling has short-term, intermediate-term, and long-term objectives
Short-term: Disperse money to be able to access it now while lowering this year’s tax bill.
Intermediate-Term: Disperse your income generating assets that produce passive income in the years leading up to retirement.
Long-term: Spreading where you access your retirement income from to decrease the taxes as you draw it.
Short-Term Income Splitting
The main consideration here is to try and have you and your spouse’s income as close to each other as possible. This is where the new CCPC dividend rules hurt the most acutely. However, there are some tools available to help with this for those in moderately high income brackets:
- Hiring your spouse and paying him/her well. They deserve it and there are lots of “fringe benefits”.
- Spousal RRSPs (After a 2-3 year delay of not making contributions)
We will examine the details of these in my follow-up posts, but a high income self-employed professional could redirect $25K to $50K towards their spouse this way without too much fuss depending on their practice type and revenue. It is not unlimited, like with dividends, where we could hose money at our spouse under high pressure. However, there are some options.
For example, if you are a family doc who bills around $350K, netting $250K/yr after your basic office overhead, and your spouse makes $50K/yr in their own job. They can take out that money out after 3 years from your last contribution and it will be taxed in their own tax bracket. Neither you nor your spouse are probably interested in your spouse becoming your office secretary. Instead, you hire them to do some basic billing and management for your practice paying another $15K/yr. This is a low-hanging fruit and the more money involved in your practice, the higher you can justify paying them. That would bring your taxable income down to $235K and hers up to $65K and drop your household tax bill from $105K to $101K. While not remotely as good as full income splitting via dividends from a CCPC where you could have lowered your corp/household tax bill to $94K every year – it is something. Furthermore, if you were paying someone else $15K to do your billing before, then those savings redirect that money to your household instead of someone else, narrowing that gap substantially.
If you use spousal RRSPs as an income splitting technique then you further drop your taxable income to $209K each year that you redirect $26K/yr to them via a spousal RRSP, lowering your tax bill to $97K for those years (but also lowering your cashflow by 12K). After 2-3 years lag of not making contributions, your spouse can take that money out taxed in their hands. If taken out before that lag, the income would be attributed back to the contributor. This limits the utility of spousal RRSPs for short-term income splitting, but it can be useful for intermediate-term goals like funding a parental leave or sabbatical where your spouses’ income from their outside job drops that year if you plan that far in advance. We fully delve into the uses of spousal RRSPs across the life cycle in a follow-up post.
How much these approaches mitigate the tax bill also depends on you and your spouse’s incomes. The closer their income to zero and the higher your income is above $220K/yr, the harder you are hit in the short-term with the rule changes. On the other end of the spectrum, there is also no point of income splitting once you have bumped their income up over $220K/yr if they are also a high earner since that would put them in the highest marginal tax bracket also. On the bright side, the higher your income (provided you don’t spend like the government, but rather create budgetary surpluses instead of deficits), the more you money you have to use for intermediate-term income splitting techniques to build up the lower earner’s income over time.
Intermediate-Term Income Splitting
These techniques revolve around having your spouse develop a portfolio of income producing assets that generate income in their hands and are therefore taxed at their rates. The big items to consider here are:
- Will you need investments in addition to those in your CCPC to fund the retirement lifestyle that you want? With the proposed rules, that will likely amount to $50k/yr plus the income from whatever portfolio you have grandfathered from before the new rules. That would equate to about a $1M portfolio returning 5%. If not sufficient, then you need to consider other investments.
- If you plan on retiring over the age of 65, and until then working enough to support all of your income needs, then you may not need to worry about Intermediate-Term Income Splitting too much. If you are over 65, you will be able to split money in your corp with your spouse using dividends. This is analogous to “pension-splitting” allowed with pensions and Registered Retirement Income Funds (RRIFs).
- If you plan on working less before age 65 and drawing on investment income to fund your lifestyle on the “glideslope” into retirement, then you need to consider intermediate-term income splitting to minimize the tax on those draws from your portfolio before you can “pension-split” over age 65.
- When implementing intermediate-term income splitting techniques, the main tax laws to be aware of are the “attribution rules”. Basically, if a higher income spouse gifts money to a lower income spouse, who then invests and earns income with that gifted money, then the income is attributed to the higher income spouse and taxed in their hands. Fear not, there are lots of nuances, some may say “loop-holes”, that can be used and I am a rope trickin’ loop-holin’ bullish doctor after all! Yee-haw – we’re gonna have some fun with this and stick it to the taxman.
The tools that we will look at:
- Paying your taxes and expenses optimally
- Joint investment accounts & Spousal personal investment accounts
- Investment loans and home equity loans
Long-Term Income Splitting
This actually gets a bit easier – I suspect because people over 65 get out, vote, and make optically poor targets for politicians. You are able to split income from RRSPs/RRIFs, CPP, and even dividends from your CCPC as long as you are over age 65. It can be a decent amount of money when you count your RRSPs, TFSAs, CCPC (which may be limited to 50K/yr income), and CCP ($8K/yr max if you take it at age 60 or $13K/yr max take at age 70).
Let’s look at a base case scenario:
- You are a single earner high income household. As is often the case, you started earning the big bucks at age 30 and plan to retire at 65.
- You took a salary of at least 145K/yr and made the maximum RRSP contribution of 26K/yr.
- You maxed both yours and your spouse’s TFSAs.
- You got max CPP at age 65.
- Assume that contribution room of the above are all indexed to inflation.
- You left enough retained earnings in your CCPC to build up $1M over your career.
- Your investments return an average of 5% after inflation and tax drag.
- You use a “safe withdrawal rate” of 4% per year to draw down your money.
- Your after-tax household retirement income would be ~165K/yr in today’s dollars.
That ain’t too shabby, plus you may even get a few thousand in old age security (OAS) on top of that since your non-TFSA income is under the clawback threshold. If you think you are going to want to spend more in retirement, then you would need to build up a non-taxable account in addition to these investments.
It becomes easier to shift things around when you are over 65, but it is still probably be prudent to have your assets as evenly distributed as possible in the years leading up to this. It would make it easier if you decide to retire or semi-retire earlier than 65 which would require both a larger nest-egg and the ability to draw income from both partner’s investments to minimize the tax. You many not be planning to retire before 65, but you could change your mind for a variety of reasons or be forced to if life throws you a curve ball.
As I hope that I have illustrated, while the changes to CCPCs change the ease and simplicity of income splitting, they do not eliminate it completely.
- The biggest blow is to short-term income splitting, but some mitigation is possible.
There are also opportunities to income-split in the intermediate term which are important if you want to build a really large nest egg to fund your Hugh Hefner retirement lifestyle or retire earlier at an age when you could enjoy that lifestyle with fewer performance enhancing drugs.
- In the long-term, income splitting becomes relatively easy when you are over 65. Evening your asset accumulation between partners in the intermediate-term leading up to that can still be important.
This was a quick overview to set the scene. We will explore each of the strategies introduced in the upcoming posts.
There many nuances and factors to consider. It is important to be an informed customer and have a good understanding of all of these strategies when planning . This applies whether you are using a financial advisor (optional, but recommended – like lingerie), an accountant (mandatory for most people – like underwear), or going commando (not recommended). It is -20C outside right now and you do not want to freeze your assets off.