Spousal Loan Tax Savings For Your Family’s Investments

Answer

A spousal loan can be a powerful tool for spousal loan tax savings, particularly when one spouse is in a higher tax bracket than the other. By strategically lending money to a lower-income spouse for investment purposes, families can effectively split investment income and reduce their overall tax burden. KWB can help you structure these loans to maximize your tax advantages while adhering to all relevant regulations.

Spousal Loans: An Edmonton Tax Planning Strategy for Families

If you are in a much higher income tax bracket then your spouse and have investments outside of an RRSP or TFSA then a spousal loan could reduce your taxes.

Money that is earned directly by you through employment or investing is considered yours and can’t just be given to your spouse to invest.  That situation will fall under the attribution rules and any income earned will be deemed to have been earned by you.  However, you can make a bona fide loan to your spouse at prescribed rates and avoid the attribution rules.

Before you think of using this strategy, ensure you are doing the other things to equalize your joint assets such as:

1. Having the higher income person paying for all the expenses of the household.
2. Making RRSP contributions towards a spousal account.
3. Utilizing any income splitting opportunities in a company you may own.

If you still have an inequity in investable assets after utilizing the above then a spousal loan could be your next strategy. Here’s how it works:

• You would transfer money to your spouse under a loan agreement so that they could start making investments in their name.
• Make sure the loan is properly documented just like any other loan, and includes repayment terms.
• Charge interest that’s at least equal to Canada Revenue Agency’s prescribed rate. Presently this rate is a very low 2%. This rate may be locked in until the loan is paid.  That way your spouse can earn say 4-5% while only paying 2% for the use of the money.
• Make sure your spouse pays the interest to you within 30 days of the end of the year. A missed payment will cause the Attribution Rules to kick in and deem the income generated by the lent money to be attributed back to you for that year and in all future years.

Here’s an example of the spousal loan strategy for a $200,000 loan at 2%.  Assuming the spouse earns 4% by investing the loan proceeds and your tax rate is 48% and your spouse’s is 25%:

_______________________         No loan (You)              With Loan (You)           With Loan (Your spouse)

Interest earned                            8,000                               4,000                     4,000 (8,000 – 4,000)

Taxes                                               3,840                                1,920                         1,000

Conclusion:  In this scenario, the family has saved 3,840 – 2,920 (1,920 + 1,000) or $920 every year through the use of this strategy.

In general this strategy is effective if:

1. The loan is a fairly large amount.  If you are saving roughly $500 per $100,000 loaned it may not make sense to do a loan for only $50,000.
2. There is a large difference in your tax rates.  The above scenario uses the highest and lowest rates in Alberta in 2018.  If the rate differential is only 3% or 7% it again wouldn’t be worth doing.
3. The investment options need to provide a good spread between the prescribed rate of 1% and what can be earned.  If there are losses then this strategy would actually increase the family tax burden. If the amount earned by the spouse is not much more than 2% then again there would be no point in implementing this strategy.

A few other things to note:

• There is no requirement to pay back the principal portion of the loan, only the interest.
• This strategy can also be used with other adults in your family unit.  Children, parents and even grandparents.
• If you have set up one of these loans in the past at a higher rate than 2%, consider redoing your documentation now so that you can use the low 2% rate.

If you would like more information or have any questions, feel free to contact us at 780.466.6204, or click here to send us an email.

Thanks to David Wickenberg of KWB Chartered Accountants for providing this content.