Pay for the grandkids’ educations

Income splitting lets a person redirect income to take advantage of the lower tax rates and tax credits available to other family members—a family’s tax burden is generally lowest when all members earn roughly the same amount of income.

While many business owners used these opportunities while working, they may not know Revenue Canada has legitimized certain income-splitting techniques for wealthy Canadians living off their investments.

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Case Study

Fred and Natalie are both retired. Fred is age 73 and sold the shares of his company just before he retired at 65. He receives a monthly CPP benefit, a retirement income fund distribution, and interest and dividends from an investment portfolio. Natalie is 67 years old and retired at 65. She receives a monthly CPP benefit. Her lower total income means she pays personal tax at the lowest marginal rate.

The couple is debt-free and helps pay for their grandchildren’s educations. They could do this more tax efficiently by using prescribed rate loans to a family trust.

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Currently, the money is coming from Fred’s after-tax investment income. Not good, since this money’s been taxed at the highest personal tax rate.

To rectify this, Fred and Natalie could loan funds from Fred’s investment portfolio at interest to a family trust, but Fred may incur personal tax on the transfer of these investments.

To avoid the attribution rules, Fred must charge interest on the loan at a rate that’s not lower than the government prescribed rate—currently 1% through the end of 2011 and perhaps into the first quarter of 2012. The family trust has to pay the loan interest no later than 30 days after the end of the year.

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So, if the family trust can earn 3% on the reinvested funds, then that income, minus the interest paid by the family trust to Fred, may be paid to the schools on behalf of the beneficiary grandchildren. The grandchildren, having low or no other income, will pay little or no tax on the amounts paid to the schools on their behalf.

This gives Fred and Natalie a tax-effective way to help fund their grandkids’ educations.

Derrick de Gannes is a senior tax manager at Cookson Walker LLP.

This article was originally published on capitalmagazine.ca.