How income splitting can lower your household taxes

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What is income splitting?

Income splitting is a strategy that aims to level out income earned by married or common-law spouses with the goal of reducing the household’s tax bill. An added benefit is that income splitting can help protect income-tested benefits such as Old Age Security, which is reduced at a higher income.

Canada has a graduated tax system meaning as Canadians earn more, they pay a higher rate of tax on the higher earning. For example, in 2024, federal tax on taxable income $55,867 or less is 15% – but every dollar earned above that up to $111,733 is taxed at 20.5%.

The effect of a graduated tax system is that two partners who each earn $100,000 will pay less total tax than two partners who earn $150,000 and $50,000, respectively. That’s where income splitting can be beneficial.

What income qualifies for income splitting?

Income splitting isn’t as simple as totalling what each spouse earns and dividing it in half. Only certain types of income qualify for income splitting, and the biggest opportunity is in retirement when you can split up to half of eligible pension income with your married or common-law spouse.

Pension income eligible for income splitting includes:

In addition, a couple can share Canada Pension Plan (CPP)/Quebec Pension Plan (QPP) income, whether one or both spouses contributed. The portion that’s sharable depends on how many months spouses lived together while contributing to the CPP/QPP. Couples cannot share the CPP post-retirement benefit, which is earned by those who both contribute to, and receive benefits from, CPP/QPP between the ages of 60 and 69 inclusive.

You cannot split Old Age Security, U.S. Individual Retirement Account (IRA) income or any other foreign pension.

Can you split income while working?

A spousal or common-law partner RRSP allows working couples to split some income right away and lay the groundwork for more equal income in retirement. It’s an effective strategy when a couple have different incomes now and expect to have different incomes in retirement. It can also work well when there is a significant age gap between spouses because the older spouse can continue contributing to a spousal or common-law partner RRSP until the end of the year the younger spouse turns 71.

Here’s how it works. The higher-income spouse contributes to the spousal or common-law partner RRSP on behalf of the lower-income spouse. In return, the higher-income spouse uses their RRSP contribution room and deducts the contribution at their marginal tax rate, which  would likely be higher if their income was higher. The deduction is received in the year of the contribution but can be carried forward and used anytime. Meanwhile, the lower-income spouse builds up retirement savings – and then, in retirement, withdrawals from the spousal or common-law partner RRSP will be taxed in that spouse’s hands.

It’s important to note that contributions to a spousal or common-law partner RRSP must generally remain in the plan for the rest of that calendar year plus two more years for withdrawals to be taxable to the spouse rather than the contributor.

Can business owners split income with family?

If you own a private company and your spouse or adult children work for you, it may be possible to pay them a salary that is taxed at their marginal tax rate. If they are shareholders of your company, you may be able to pay them dividends. However, there are strict and complex Tax on Split Income (TOSI) rules that must be met for this strategy to work – otherwise, the dividends will be taxed at the top marginal tax rate. Once the business owner turns 65, the TOSI rules no longer apply and it becomes easier to split income in this way. It’s essential to work with a tax professional if you’re interested in splitting business income with family members.

Income splitting requires regular reviews

Income splitting, like all tax planning, is not a “set it and forget it” strategy. It’s a good idea to review your situation with your advisor every year so you can adjust as needed.

During working years, for example, one spouse may start out earning a higher income – but that can change. Either spouse may change careers, taking a step down or up with their earnings. Also, either spouse may get a job with a more or less generous pension plan, which reduces RRSP contribution room. Couples can have a spousal or common-law partner RRSP for each spouse so, if your circumstances today and/or outlook for retirement change, you can consider switching who contributes to whose retirement savings.

In retirement, income levels tend not to change as much, but one spouse may decide to keep working longer than the other or inherit an investment portfolio that generates significant income. These situations, too, may require fine-tuning of the couple’s income splitting strategy.

How we can help

Income splitting is just one way to ensure your household gets the most out of income earned. Your Edward Jones advisor can work with you to develop a customized approach that considers many aspects of your personal and family situation to save taxes and enhance your financial well-being.