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September 12, 2016 | Lend Cash at 1% Rate to Your Spouse

Adrian Mastracci

Adrian Mastracci, Discretionary Portfolio Manager, B.E.E., MBA. My expertise in the investment and financial advisory profession began in 1972. I graduated with the Bachelor of Electrical Engineering from General Motors Institute in 1971. I then attended the University of British Columbia, graduating with the MBA in 1972. I have attained the “Discretionary Portfolio Manager” professional designation. I am committed to offering clients the highest standard of personal service by providing prompt, courteous and professional attention. My advice is objective, unbiased and without conflicts of interest. I’m part of a team that delivers comprehensive services and best value in managing client wealth.

I want to revisit the benefits of one of the few remaining family income splitting strategies.
It is commonly known as the prescribed rate loan.

The idea needs two components to succeed:

One spouse is in a lower income tax bracket than the other, or earns little income.
The higher tax bracket spouse has cash to lend to the other spouse.

The key is to charge interest at least at the prescribed rate on cash loaned to a spouse/partner.
That prescribed rate is now set at 1% for loans made by September 30, 2016, likely longer.

Further, the low 1% loans don’t have to be repaid for a long time, say 5 to 10 years or more.
The lower income spouse aims to accumulate a larger nest egg while the family pays less tax.

My sample case highlights the income splitting strategy (figures annualized):

The higher tax bracket spouse lends $100,000 to the other at the 1% prescribed rate.
The recipient spouse invests the cash, say at 3% ($3,000) and reports the investment income.

The recipient must pay 1% annual interest ($1,000) to the lender spouse.
The lender spouse is taxed on the 1% interest, while the recipient deducts it.

The recipient is taxed on the 2% net income ($3,000-$1,000).
This results in annual income of $2,000 shifted to the lower income spouse.

A promissory note is evidence for the loan.
A separate investment account is preferred for the recipient.

These loans are best made for investment reasons, like buying dividend paying stocks.
A new 1% loan can also refinance an existing higher rate prescribed loan.

Those receiving or contemplating OAS should review implications of clawback on both spouses.
It may be sensible for the lender spouse to generate more cash for such loans.

Multiple prescribed loans can be made at 1% while the rate does not change.
Business owners can investigate the viability of prescribed loans to shareholders.

An alternative to the prescribed loan strategy is to invest and be taxed in the hands of the higher bracket spouse.
This implies the family has to forego the benefits of income splitting.

A simplified method to think of such loans is:

Prescribed Rate Loan – Sample Case

Cash Borrowed at 1% Rate = $100,000

Indicated Investment Income (3%) $3,000
Less: Prescribed Loan Interest (1%) $1,000
_________________________________________
Taxable Income for Borrower Spouse $2,000

Taxable Interest for Lender Spouse $1,000
_________________________________________
Source: KCM Wealth

The benefit of the strategy is the family after-tax sum of one approach vs another.
Shifting income into the hands of the lowest taxed spouse is your mission.

Today’s prescribed rate, which is set quarterly, is as low as it can go (next setting soon).
However, expect it to rise when the bank rate rises.

Check out your family benefits of this income splitting opportunity.
All arrangements and documentation must be in place at least by September 30, 2016.

Time marches on for the low rate.
Follow the rules carefully when lending cash at the prescribed rate.

Your questions are invited.

Talk soon,

Adrian

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September 12th, 2016

Posted In: Adrian Mastracci Blog

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