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| Adrian Mastracci, president of KCM Wealth Management, says “Follow the rules closely if you intend to take advantage of this planning opportunity at the 2% rate. All your strategies, arrangements and documentation must be in place not later than September 30, 2004." |
For Immediate Release
Vancouver, BC (July 8, 2004): No such luck. We’re not borrowing from the Bank of Canada.
However, an important planning opportunity exists where one spouse, including a common-law partner, is in a lower income tax bracket than the other. It involves loaning funds from one spouse to the other.
Adrian Mastracci, investment counsel at Vancouver based fee-only KCM Wealth Management comments, “You may consider lending your spouse some money if your spouse is in a lower income tax bracket than your own or has low income. The benefits are well worth looking at.”
“The key is to charge interest at least at the Canada Revenue Agency prescribed rate on all funds loaned to your spouse,” notes Mastracci, "This has nothing to do with bank loan rates."
“The great news is that the prescribed rate has dropped to 2% for the third quarter ending September 30, 2004,” remarks Mastracci, “Better yet, the loan rate can be locked in for a long period of time, say five to ten years.”
“The recipient spouse invests the funds and reports the income earned on the investments,” says Mastracci, “However, the recipient must pay the interest to the lender spouse before January 30 of each year following the loan.”
“Let’s illustrate the process. Say one spouse loans $100,000 to the other at the 2% prescribed rate who then invests it at 5%. The recipient spouse is then taxed on the 3% difference,” explains Mastracci, “In this instance, an annual income of $3,000 is shifted to the lower income spouse.”
“Making this a long-term arrangement has plenty of planning appeal,” states Mastracci, “All of the investment income in excess of 2% can be taxed in the hands of the lower tax bracket spouse.”
Keep in mind the following about prescribed rate loans:
- Documentation between the spouses is required as evidence of the loan.
- There must be actual loan interest payments made to the lending spouse.
- The lending spouse reports the 2% loan interest income.
- The CRA prescribed rate is set every calendar quarter.
- The 2% prescribed rate is the lowest ever, matching the second quarter 2002.
- The prescribed rate may rise for the fourth quarter 2004 and beyond.
- Make sure you pay attention to all the rules.
“This is one of the few forms of income splitting still available to spouses,” outlines Mastracci, “Over time the lower income spouse can accumulate a bigger nestegg.”
“It can then be used as a source of income both now, and during those financial independence or retirement years,” points out Mastracci.
“You may already have such a loan at a higher interest rate,” mentions Mastracci, “Hence, a new loan could be used to refinance the existing one at the lower rate.”
“Loans to a spouse should be made for investment purposes,” indicates Mastracci, “The recipient spouse pays the prescribed rate regardless of the loan purpose.”
“This loan provision is also available for children,” remarks Mastracci, “However, you may need a family trust if minor children are involved.”
“For business owners, there are other variations on this income splitting opportunity that involve family trusts and loans to shareholders,” outlines Mastracci, “The shareholder loan rules are much more involved. Therefore, seek professional counsel.”
“A couple of uses for prescribed loans from the employer or your business are the purchase of a home or an automobile,” mentions Mastracci.
“Speak to your advisors about how you may benefit from this provision,” suggests Mastracci, “Some financial rearrangements may be necessary.”
“Clearly, this income splitting provision can provide significant income tax savings. Especially over a number of years,” concludes Mastracci, “More importantly, the family nestegg improves.”
“Follow the rules closely if you intend to take advantage of this planning opportunity at the 2% rate,” summarizes Mastracci, “All your strategies, arrangements and documentation must be in place not later than September 30, 2004.”
Mastracci ends, “These golden opportunities don’t come along often enough.”
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