Yahoo Finance Married Canadians: Know This Before Filing Your Taxes
Written by Andrew Button at The Motley Fool Canada
If you’re married, you might be surprised to learn that your marital status has some bearing on how you should file your taxes. The most obvious difference between filing as part of a couple and filing as a single person is the option to file a joint tax return. You probably already know that one, but there are other differences that aren’t so well publicized. In this article, I will explore a key difference between filing taxes as an individual vs. filing as a couple, that all married Canadians should know about.
You can split your pension income with your spouse
A big difference between married couples and single Canadians is the fact that the latter can take advantage of pension income splitting. Pension income splitting is a strategy whereby the higher earning spouse transfers income to the lower earning spouse. By doing this, the couple pays less taxes on the pension income. This assumes that one spouse is below the province’s top tax bracket, of course. If one partner makes $1 million a year and the other makes $500,000 a year, income splitting will have no effect.
If one partner earns a lot less than the other, then the money saved can be quite substantial. Let’s imagine you have a 50% marginal tax rate and your partner has a 20% marginal tax rate. If you transfer $50,000 in pension income to your partner, you reduce the taxes payable from $25,000 to $16,750. The former is a 50% tax on $50,000, the latter a 33% tax on $50,000. I calculated the lower earning partner’s taxes at 33% rather than 20%, because an extra $50,000 in income would cause the latter’s tax rate to rise. Still, at 33%, it results in much less taxes than having the whole $50,000 sum taxed at 50%.
That includes RRSP income!
When you hear the expression “pension income,” you probably immediately think of CPP and employer-sponsored pension plans. Those definitely count, but RRSP income counts too. So, even if you don’t have a big employer sponsored pension coming your way, you can still benefit from pension income splitting.
Another RRSP benefit to married couples is worth mentioning here: split contributions. The higher earning partner can make an RRSP transfer to the lower earning partner, thus increasing the value of the tax refund produced by the contribution. This strategy not only increases the refund, it also leaves the lower earning partner with all of his/her contribution room intact, therefore enabling him/her to achieve a higher RRSP balance than would otherwise be possible.
What kinds of investments are best?
If you’re going to be doing income splitting with an RRSP, it pays to think about what kinds of assets to hold in the RRSP. Dividend-producing assets are often considered ideal for RRSPs, as dividends create automatic cash flows that are taxable if not held in an RRSP or a TFSA.
Consider Brookfield Asset management (TSX:BAM, for example. It’s a Canadian non-bank financial company that has a 3.3% dividend yield. I personally hold a small position in this stock, as the company behind it (Brookfield) has a great long-term track record, and BAM itself has a sky-high 50% net profit margin.
I could talk until I’m blue in the face about the virtues of BAM (its high margins, dividend growth, and strong brand), but the point here is how its dividends are taxed. Because it pays out dividends each and every quarter, BAM is taxable whether or not you sell it. In an RRSP, those dividends can compound tax free until the day you retire, or age 72 (whichever comes first). Outside an RRSP, the dividends may be taxed heavily. By holding stocks like BAM in an RRSP, you optimize your tax strategy and generate dividend income that can be withdrawn and given to your spouse. Talk about a win-win situation.
The post Married Canadians: Know This Before Filing Your Taxes appeared first on The Motley Fool Canada.
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Fool contributor Andrew Button has positions in Brookfield and Brookfield Asset Management. The Motley Fool recommends Brookfield, Brookfield Asset Management, and Brookfield Corporation. The Motley Fool has a disclosure policy.
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