Why is it time to take advantage of prescribed rate loans for income splitting
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Advisors are urging more clients to consider prescribed rate loans before the bottom rate rises, possibly as early as July 1.
Prescribed rate lending is an income splitting strategy in which a spouse with a higher income lends money to a spouse with a lower income in order to reduce their collective tax bill. The money is loaned at the Canada Revenue Agency (CRA) “prescribed interest rate”, which is currently 1% – the lowest rate available. It has been at this level since the third quarter of 2020, when it was reduced by 2%.
The prescribed rate is set quarterly based on the average rate for Government of Canada 90-day Treasury Bills auctioned for the first month of the last quarter. Given that the average was 1.2% for April, the rate should climb to 2%.
Laura Barclay, senior portfolio manager at Private Investment Advice, TD Wealth Management Inc. in Markham, Ont., says the window is closing for families to take advantage of the reduced rate.
“We know we’re good until June 30,” she said. “The risk is where we will be for July 1.”
Ms Barclay says tax season is a good time to set up these loans, as crunching the numbers can often present various income-splitting options.
“If we have a spouse who has a high income and a spouse who earns less, we want the assets generating the investment income to land with the low-income spouse – and the way to do that is through the structure of prescribed rate loan. ,” she says.
Another reason to do it now before the rate goes up is that the percentage is locked in for the life of the loan, Barclay says, regardless of any changes to the prescribed interest rate announced later.
She adds that the loans can also be canceled if necessary. Once the loan is in place, the lending spouse transfers the funds to the borrowing spouse through a promissory note.
Ms Barclay says the loan must be properly documented, including interest payments, to comply with CRA rules.
While borrowed funds don’t necessarily need to be immediately invested in the market, she says it’s the best way to split income and minimize taxes.
Interest payments on prescribed rate loans are paid at least annually by January 30, and the Io Interest paid must be included in the lender’s taxable income.
Ms Barclay says the strategy also works when splitting income with minor children, with the borrower being the family trust.
– Brenda Bouw, Globe and Mail Special
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