Income splitting is a tax planning strategy in Canada that allows higher-income earners to shift certain types of income to lower-income family members, reducing the overall family tax bill.
Because Canada uses a progressive tax system, the more you earn, the higher your marginal tax rate—so spreading income across family members can create significant savings. Here are the main Canadian tax benefits and how they work:
1. Lower Overall Family Tax
Canada’s federal and provincial tax systems are progressive. If one spouse earns $180,000 and the other earns $30,000, the higher earner pays tax at a much higher marginal rate.
By splitting eligible income:
- More income is taxed at lower marginal rates.
- The couple may reduce total combined taxes.
- Some income may avoid being taxed at the highest brackets altogether.
2. Pension Income Splitting (Age 65+ or qualifying pensions)
This is one of the most common and valuable forms of income splitting.
Eligible pension income (such as life annuity payments from an RRSP/RRIF after age 65) can be split up to 50% with a spouse or common-law partner.
Benefits:
- Reduces the higher earner’s marginal tax rate.
- Allows both spouses to claim the federal pension income tax credit.
- May reduce Old Age Security (OAS) clawback exposure.
Example:
If one spouse receives $60,000 in eligible pension income and the other has little income, splitting $30,000 may significantly lower total tax.
3. Spousal RRSP Contributions
A higher-income spouse can contribute to a spousal RRSP in the lower-income spouse’s name.
Benefits:
- The contributor gets the tax deduction now (at a higher rate).
- Withdrawals in retirement are taxed in the lower-income spouse’s hands.
- Helps balance retirement income and reduce future tax burden.
This is especially useful if one spouse expects much lower retirement income.
4. Prescribed Rate Loans (Investment Income Splitting)
A higher-income spouse can loan money to a lower-income spouse at the CRA prescribed interest rate (which must be charged and paid annually).
Benefits:
- Investment income earned is taxed in the lower-income spouse’s hands.
- Can generate significant long-term tax savings.
- Particularly effective when investment returns exceed the prescribed rate.
Proper documentation and annual interest payments are required to avoid attribution rules.
5. Canada Child Benefit (CCB) Optimization
Because CCB is income-tested based on family net income:
- Income splitting strategies that lower adjusted net family income can increase CCB payments.
- Reducing one spouse’s income through RRSP contributions may improve eligibility.
6. Reduction of OAS Clawback
Old Age Security begins to be clawed back once income exceeds a certain threshold. Income splitting can:
- Keep the higher-income spouse below the clawback threshold.
- Preserve some or all OAS benefits.
7. Capital Gains and Dividend Planning
While Canada has attribution rules preventing simple transfers of investment assets to a spouse, proper structuring (e.g., prescribed rate loans) can legally shift:
- Dividend income
- Capital gains
- Rental income
When done correctly, this lowers family-wide tax.
Important Limitations
- Canada has strict attribution rules to prevent abusive income shifting.
- TOSI (Tax on Split Income) rules limit income splitting with adult children in many situations.
- Professional advice is strongly recommended before implementing strategies.
Who Benefits Most?
Income splitting tends to provide the greatest benefit when:
- There is a large income gap between spouses.
- One spouse is in a high marginal tax bracket.
- The couple is nearing or in retirement.
- Investment income is significant.
Canadian income tax is becoming more complicated every year. Getting your tax return prepared by a professional at our office may save you money. Do not hesitate to contact us to arrange a reveiw of your tax situation.