Income splitting is one way to lower how much you pay in taxes. Some high-net-worth Canadians take advantage of a prescribed-rate loan to split their investment income with a spouse, common-law partner or their children. But if you want to do this as cost-effectively as possible, time is running out. On April 1, the prescribed interest rate doubles to two percent.
This is the rate set by the CRA for loans you make to your spouse, or other family members. Right now, the rate is a lowly 1 percent, but on April 1, doubles to 2 percent (Thanks a lot, CRA). These prescribed rate loans can be used for income splitting.
“How do I use a prescribed rate loan to reduce what I pay the tax man?”
The basic idea of this financial maneuver: a higher income lender to loan money to a lower income borrower, who then invests the money in an investment portfolio. All the income from the investments are taxed in the hands of the lower income borrower. However, the higher income lender just has to report the interest income.
You’re helping a lower-income family member to invest – and those investments are taxed at a lower rate. You lend money to your spouse or child if they earn less than you. They just have to pay you interest at least once a year at the prescribed rate!
The best part about these loans is that when you set up the loan, you lock in that super-low rate for good. Create the loan before the interest rate changes, and your spouse or child is paying you back at that 1 percent rate. Wait until April 2 and you have to charge the higher rate.
“How does this work? Do I have to fill out any extra paperwork for this?”
You’ll want to discuss this with a qualified tax advisor to make sure the strategy is right for you. As well, you’ll need a qualified legal advisor (ie. a lawyer or notary) to draft or review a loan agreement.
Is your loan set up? Great! Now, the lender reports interest income from the loan on their tax return. Meanwhile, the borrower reports any investment income on their return.
“This seems complicated. Can a WealthBar adviser help with this?”
Absolutely. Get in touch in the usual way, either using the app on your smart device or by messaging client services!