Retirement income planning for you and your spouse

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patmckeoughBy Pat McKeough, TSINetwork.ca

Special to the Financial Independence Hub

There are a few retirement income planning steps you and your spouse can take to lower your taxes.
These steps work especially well if your spouse makes a lower income than you do.

There are lots of ways to shift investment capital and income to the lower-income spouse. This lets you lower your overall tax bill right now. It also ensures that each spouse gets roughly the same amount of income in retirement. That will cut taxes later, as well.

We’ve discussed other retirement income planning techniques like paying your spouse’s bills, setting up a spousal RRSP and swapping assets for cash or shares. Here are more ideas:

Reinvesting attributed income

Revenue Canada won’t let a higher-income spouse simply give money to a lower-income spouse. “Attribution” rules apply if you do that. The original, higher-income spouse must pay tax on any gains or investment income from those funds. However, gains from reinvesting that initial earned income are only taxable in the hands of the lower-income spouse.

For example, if the higher-income spouse gives the lower-income spouse $10,000 to invest at 10%, the $1,000 in interest income is taxable to the higher-income spouse. But if the lower-income spouse then invests the $11,000, the gain on the extra $1,000, or $100, is taxable to the lower-income spouse. Over time, this “secondary” income could grow to be a significant investment asset for the lower-income spouse.

Lending money to a spouse

Attribution rules also apply if you lend money to a spouse for investment, unless you charge interest. The interest rate must be either a commercial rate of interest, or equal to Revenue Canada’s prescribed interest rate, which is set every three months. The Revenue Canada rate is calculated based on the average yield of 90-day treasury bills sold during the first month of the previous quarter. The rate used is the one for calculating taxable benefits from low-interest and interest-free loans to employees and shareholders.

This rate currently stands around 1%. That’s much lower than most commercial borrowing rates. The lower-income spouse can then invest the borrowed funds at a higher rate. This can include a combination of interest, dividends or capital gains

That means the difference between the Revenue Canada rate and the returns on the invested funds is taxed in the hands of the lower-income spouse. The lower-income spouse can also deduct the interest payments on his or her tax return. When the loan is set up, the rate can be permanently set, whether the loan is for one year, 20 years or indefinitely.

That’s an added advantage, especially now, with the prescribed rate near all-time lows.
Note that to meet Revenue Canada’s requirements, the interest must actually be paid from the lower-income spouse to the higher-income spouse. It must be paid each year, or by the following January 30. The higher-income spouse must report the interest as interest income.

It’s a good idea to draw up a formal promissory loan agreement or note between the spouses. It should detail the term of the loan, and include the prescribed rate during the current calendar quarter.

Pay interest on investment loans

If the lower-income spouse takes out an investment loan from a third party, such as a bank, the higher-income spouse can pay the interest on that loan. No attribution accrues to the higher-income spouse, providing they don’t pay any of the loan principal. The higher-income spouse should make sure to pay the interest with a personal cheque bearing his or her name, so it’s directly tied to them.

The interest payments on the loan are deductible on the lower-income spouse’s tax return, even though the higher-income spouse pays them. This technique lets the lower-income spouse build up a larger investment base.

Turn retirement income planning into a game

Retirement income planning doesn’t have to be about moving money around. Sometimes it’s easier to live frugally. People who come from humble circumstances often develop a degree of both frugality and industriousness early in life.

Finding part-time work while in school, and making every penny count, becomes a game for them. It’s easy to let frugality evaporate in mid-life, when money becomes more plentiful. But some find that if they return to frugality later in life, it’s more fun than ever. It’s a little like taking pleasure from a game that you haven’t played since you were young.
Your enjoyment of, or distaste for, frugality is partly a matter of attitude. But that’s under your control. Don’t think of it as penny- pinching. Think of it as taking charge of a part of your life, so that more of your money goes to things you choose.

Retirement income planning can be tricky to navigate if you or your spouse makes a significant amount of money. Are you in a similar situation? Are both you and your spouse already retired? Share your thoughts and experiences with us in the comments.

Pat McKeough has been one of Canada’s most respected investment advisors for over three decades. He is the founder and senior editor of TSI Network and the founder of Successful Investor Wealth Management. He is also the author of several acclaimed investment books.

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