Income Splitting in Canada: A Simple Way to Reduce Taxes in Retirement
Many Canadians focus on saving for retirement but overlook income splitting, a strategy that may reduce their taxes in retirement.
For Canadian couples, income splitting can be a valuable strategy that may help reduce the amount of tax paid in retirement. Eligible couples can allocate certain types of retirement income between spouses, which can lower the family's overall tax bill when one spouse earns significantly more than the other.
How Does It Work?
Canada's tax system is progressive, meaning higher income is taxed at higher rates. When retirement income is concentrated with one spouse, that person may end up paying more tax than necessary. Sharing eligible income can help balance taxable income and potentially create tax savings.
Common Income-Splitting Strategies
Some of the most common approaches include:
Pension income splitting in retirement:
Eligible retirees can allocate up to 50% of qualifying pension income to their spouse or common-law partner on their annual tax return. This can help equalize taxable income between spouses and create meaningful tax savings.
Spousal RRSP contributions during your working years:
For couples who are still working and saving for retirement, a Spousal RRSP can be an excellent planning tool.
The higher-income spouse contributes to an RRSP in the other spouse's name and receives the tax deduction. Later, when funds are withdrawn in retirement, the income is generally taxed in the hands of the lower-income spouse, potentially resulting in lower taxes over time.
CPP pension sharing for eligible couples:
- CPP sharing is separate from pension income splitting and requires an application, but it can help balance retirement income and improve tax efficiency for some couples.
Each strategy has its own rules and eligibility requirements, but all are designed to help couples keep more of their retirement income.
Plan Ahead
One of the biggest opportunities with income splitting is planning early. Building retirement assets strategically can provide greater flexibility later and may result in lower taxes throughout retirement.
Final Thoughts
Income splitting isn't the right solution for every couple, but when there is a significant difference in income between spouses, it can be an effective way to improve tax efficiency and make retirement savings go further. A financial advisor can help determine whether it's a strategy worth considering for your unique situation.
Source: https://www.wealthsimple.com/en-ca/learn/how-income-splitting-works