How to invest with spousal loans for Canadians—and how to pay it back
When a taxpayer loans money to their spouse at the CRA prescribed rate, the borrower must pay interest each year to the lender. The interest is tax deductible to the borrower and reduces the resulting net investment income from the invested funds. The interest is taxable to the lender spouse, just as if they earned interest on a bond or savings account.
To the extent the borrower can earn a higher return on the borrowed funds than the interest rate, the incremental income is effectively shifted from the higher income spouse to the lower income spouse, resulting in tax savings.
You would not normally do a spousal loan for $10,000. Generally, it is for larger amounts like $100,000. Loaning $100,000 at 2% and investing it at 4% could shift the difference of 2% or $2,000 of income from one spouse to the other.
Do spousal loan strategies shift in retirement?
It sounds like you did things right in the first place, Ghislain, by transferring investments to your wife when the loan was established and claiming the capital gain on the disposition based on the fair market value (FMV). A spousal loan can be established using cash or by transferring investments you already own.
Once retired, it is often easier to split income by way of pension income splitting on tax returns for you both. Eligible pension income that can be split includes common income sources, like registered retirement income fund (RRIF) withdrawals after age 65, and defined benefit pension income.
How to repay a spousal loan immediately or over time
If you want to unwind a spousal loan, you can certainly do so, Ghislain. It would be done the same way as paying off any other loan—by repaying the lender.
- Sell the assets of the investment loan
If your wife does not have cash available, she may have to sell the investments purchased with the spousal loan. If the investments have appreciated in value, selling them may trigger capital gains tax for her.
You will have to determine if this is worth it for you both or if you can simply equalize your incomes in retirement by using pension income splitting.
- Partial loan repayment
You could also do partial loan repayments, as she takes withdrawals from the accounts over time. So, if you and your wife need a $10,000 withdrawal for cash flow purposes, it could be done as a loan principal repayment to you. Then it is used for your shared expenses. In this way, you can retire the loan over time rather than all at once.
- Using RRSP contribution room to pay
If your wife has RRSP room, you could repay the loan in a single year, and she could make an RRSP contribution to offset the income inclusion.
The decision is yours
There is no “right” answer on how to do this, Ghislain, so you will need to consider all the unique factors about both your incomes and cash-flow needs.
One of the benefits of developing a retirement income plan on your own or with a professional is to try to forecast these types of things in advance, to allow as much time as possible to optimize the strategy.