Why now’s the 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 rock-bottom rate rises, possibly as early as July 1.

The prescribed-rate loan is an income-splitting strategy in which a spouse with a higher income lends money to a spouse with a lower income to decrease their collective tax bills. The money is loaned at the Canada Revenue Agency’s (CRA) “prescribed interest rate,” which is currently 1 per cent – the lowest rate available. It has been at that level since the third quarter of 2020, when it was reduced from 2 per cent.

The prescribed rate is set each quarter based on the average 90-day Government of Canada T-bill rate auctioned for the first month of the last quarter. Given that average was 1.2 per cent for April, the rate is expected to rise to 2 per cent.

Laura Barclay, senior portfolio manager at TD Wealth Private Investment Counsel Inc. in Markham, Ont., says the window is closing for families to take advantage of the lower rate.

“We know we’re good until June 30,” she says. “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 the number crunching can often present various income-splitting options.

“If we have one spouse who’s a high earner and one spouse is a lower earner, we want the assets generating the investment income to be landing with the lower-income spouse – and the way to do that is through the prescribed-rate loan structure,” she says.

Another reason to do it now before the rate rises is because the percentage is locked in for the life of the loan, Ms. Barclay says, regardless of any changes in the prescribed interest rate announced later.

She adds the loans can also be undone if needed. 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 should be properly documented, including interest payments, to comply with CRA rules.

While borrowed funds don’t necessarily need to be invested in the market right away, she says it’s the best way to achieve income splitting and tax minimization.

The interest payments on the prescribed-rate loans are paid at least annually on or before Jan. 30, and the loan 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, special to the Globe and Mail

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