Financial Planning for couples – an important topic that is rarely discussed
Financial planning for couples is a topic that is very important but rarely gets discussed. That’s because the strategies can be complex and as a result many couples are faced with the pitfalls and missed opportunities. This is even more prevalent in situations in which one spouse has taxable income of more than $200,000 thus putting them in the highest marginal tax bracket and the other spouse has little to no taxable income. But the solutions may be more profitable!
Common mistakes couples make
A spouse that has little to no taxable income investing in a non-registered account with the income earned by the other spouse.
It is a common mistake to move investments into the name of the low-income spouse that if caught by the Canada Revenue Agency (CRA) result in a hefty future tax bill that would also have penalties and interest added.
Not using a spousal RRSP to split income in retirement.
A spousal RRSP lets couples split their income after they retire, which reduces the family’s future tax burden. Essentially when you retire, you will both withdraw a similar amount of money from your RRSPs. Under the current tax laws this benefit to a spousal RRSP is somewhat lost because regular RRSPs and pension income can be notionally split annually when the spouse withdrawing the proceeds from their RRSP is 65 and older. That being said, the annual notional split benefit at 65 and older is something that in the future can be removed by the government, whereas the spousal RRSP guarantees a future split in RRSP income. Also remember that each spouse may benefit from the $1,000 retirement income deduction. Why not get two deductions?
Financial planning strategies
Spousal Loan Strategy
A spousal loan strategy can be used to split income. This can be done by entering into a prescribed rate loan arrangement between the spouses. The prescribed rate that must be charged is 1% right now. The lower taxed spouse will be taxed on the investment income, which effectively reduces the family’s overall tax bill. Here is an example: One spouse has 0$ taxable income and the other has $250,000 of taxable income, the highest marginal tax bracket. The spouse in the highest tax bracket has $1MM to invest. The $1MM is lent at the CRA prescribed rate to the lower income spouse to invest in a non-registered account thus attributing all the investment income to the lower income spouse. Moreover, the advantage of a prescribed loan agreement is amplified when interest rates are low.
Spousal RRSP
Spousal RRSPs have a 3-year attribution rule. This means that contributions to a spousal RRSP cannot be taken out for at least three years after the date they were put in. If the funds are taken out within 3 years, the money becomes taxable income for the contributing spouse. Splitting income with spousal RRSPs before retirement is often ignored but can sometimes make sense under certain circumstances. For example, a spousal contribution can be made by the higher taxable income spouse and they would get a substantial tax savings given that they are in the highest marginal tax bracket. After the 3-year attribution rule is respected, the low to no taxable income spouse can take out the money from the RRSP with paying little to no taxes. The overall tax burden to the family would be lower.
Next steps
Building your own financial plan is an option but if your situation is complex with many variables at play we encourage you to consult with a professional Financial Planner to determine what planning strategies you and your spouse can benefit from. Moreover, a Financial Planner would be able to examine your unique set of circumstances and apply their knowledge so that your overall financial plan remains on track.
