Spousal Loans – Should you take advantage of a spousal loan for tax opportunities?
Welcome back! Since this is the first article of 2020, we thought it would be fun if we gave you twenty reasons why a spousal loan can be such a wonderful tax planning tool!
Then we realized we have a whole tax season in front of us so we’re going to save some of that energy and give you three.
What is a spousal loan?
As some of our clients already know, a spousal loan is a terrific tool to move money from a higher income spouse to a lower income spouse in order to reduce tax overall and balance the retirement savings of the couple.
Essentially it is an agreement between two spouses to loan money from the higher income spouse to a lower income spouse at CRA’s current prescribed rate, which as of January 2020 is 2% per annum. This rate is locked in for the life of the loan as long as all of the criteria continue to be met. BUT the interest MUST be paid by January 30 each year.
The spousal loan allows the lower income spouse to invest the funds and generate investment income. They will also have an interest deduction for the loan interest. The higher income spouse would have interest income from the loan, but possibly reduce other investment income (since less is invested in their name). The loan basically shifts who earns and reports the income.
What are the criteria for a spousal loan?
When setting up a spousal loan, there are certain criteria which need to be met in order to avoid income being attributed back to the higher income spouse.
1. The loan must be properly documented, with terms of repayment, interest and the other details of the loan.
2. Ensure that the interest is repaid by January 30 of EVERY year. If this is missed, the income earned from the investments will be taxed on the higher income spouse’s return, not only in the year of the missed payment but in ALL future years. The spousal loan essentially becomes voided.
3. The interest charged on the loan must be equal to at least the CRA’s current prescribed rate (2020 – 2%).
Why use a spousal loan?
There are three distinct advantages to using a spousal loan.
1. Income attribution avoidance.
If cash is simply given to the lower income spouse, the investment income could be attributed back to the higher income spouse and taxed at the higher rate. The loan eliminates the possibility of attribution.
2. Unused tax opportunities
There may be unused contribution room in the lower income spouse’s RRSP or TFSA which could be taken advantage of.
3. Retirement cash flow planning
In retirement, in order to minimize tax, it is beneficial to have both spouses drawing similar income if possible. This can help keep income in a lower tax bracket and help retirement savings last longer!
When does a spousal loan make sense?
Every situation is different, but generally spousal loans begin to make sense when one spouse is taxed at a much higher rate than the other, or one spouse has a much larger retirement savings built up than the other.
This article is only a brief overview of the spousal loan, and there are many considerations when using this tool.
If you would like to discuss spousal loans further, please give the VR team a call.
And for those clients who already use spousal loans, don’t forget that payments are due no later than January 30!