During my working years I transferred non-registered investment shares to my wife (a stay-at-home mother) using a spousal loan. At the time of each transfer I reported the capital gain and paid the tax on the difference between the fair market value (FMV) and the adjusted cost base (ACB). Over time we also made additional spousal loans using savings from my executive compensation.
Now that I’m retired and can split pension income with my wife, we’re wondering whether to keep these spousal loans in place. She pays me the prescribed interest each year and I report that interest as income. What is the best strategy to have the loans repaid with minimal tax consequences? The market value of the investments, including unrealized gains, now exceeds the outstanding loan amount.
—Ghislain
How spousal loans work in Canada—and what to avoid
Thanks for the question, Ghislain. For readers new to this, a spousal loan is a deliberate strategy used in Canada to shift investment income from a higher-income spouse to a lower-income spouse while remaining compliant with the income attribution rules set by the Canada Revenue Agency (CRA).
Attribution rules generally cause investment income and capital gains generated from gifted funds to be taxed back to the gifting spouse. That’s why a simple gift of cash intended for tax planning will usually fail: the income produced by those funds will still be attributed to the donor, not the recipient.
To avoid attribution, a married or common-law couple can document a bona fide loan at the CRA’s prescribed interest rate at the time the loan is made. If that formal loan is in place and interest is paid annually, the borrower reports the interest as a deduction and the lender reports the interest as income. The investments themselves are owned by the borrower, so any investment returns beyond the prescribed interest are taxed in the borrower’s hands.
There are exceptions where attribution does not apply, notably when funds are contributed to registered plans such as a Registered Retirement Savings Plan (RRSP) or a Tax-Free Savings Account (TFSA). Attribution rules primarily affect taxable, non-registered accounts.
Tax reporting and the prescribed rate
The key to a valid spousal loan is documenting the loan amount, the date, a schedule of annual interest payments at the CRA-prescribed rate in effect at the time the loan was made, and ensuring interest is actually paid each year. If these conditions are met, the borrower may deduct interest paid on investment income and the lender includes the interest received as taxable income.
Because the prescribed rate can change over time, many couples set up loans when the rate is low. If the borrower earns a higher return on invested funds than the prescribed rate, the excess income is effectively taxed at the borrower’s lower marginal rate, creating tax savings for the family overall.
Does the strategy change in retirement?
Retirement often changes the family tax picture. Pension income splitting becomes available and can simplify income shifting between spouses. Eligible pension income sources, such as defined-benefit pensions or certain registered retirement income fund (RRIF) withdrawals, can be split on tax returns, reducing the need for non-registered spousal loan arrangements.
Given your situation—where you now can split pension income—keeping large spousal loans in place may no longer be the optimal approach. That said, each household is different: the decision should weigh current and projected incomes, expected investment returns, cash‑flow needs, and estate planning goals.
Options to repay or unwind a spousal loan
If you decide to unwind the loans, here are common, practical approaches to consider:
- Sell the investments purchased with the loan. If your wife doesn’t have cash on hand, she may need to liquidate the assets that were bought with the loan proceeds. That sale could trigger capital gains in her hands if the investments have appreciated. Compare the tax cost of realizing gains now with the benefits of repaying the loan.
- Repay the loan gradually. Instead of a single lump-sum repayment, you can take repayments from account withdrawals as needed. For example, if you require $10,000 of cash flow, that amount can be treated as a principal repayment to you rather than a new distribution, allowing the loan to be retired over time.
- Use registered plan contributions to offset income. If your wife has RRSP contribution room and can make a sizable contribution in the year she realizes gains or receives loan repayments, the RRSP deduction can reduce her taxable income and mitigate the tax impact of repaying the loan.
Making the right decision for your retirement
There’s no single “right” answer for every couple. You’ll need to balance tax implications, cash-flow needs, and your broader retirement and estate plan. A thoughtful retirement income plan—either self-directed or developed with a professional—can help you forecast outcomes and allow time to implement the least costly strategy.
Retirement decumulation is about more than ensuring you have enough money. It’s about sequencing withdrawals, minimizing taxes over time, and preserving value for beneficiaries. Given the trade-offs involved in selling appreciated assets, preserving income splitting, and repaying loans, many couples review these decisions with a financial planner or tax professional who can model tax scenarios for their personal situation.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products.
Read more from Jason Heath:
- Do you have to split your estate evenly between your children?
- Taxes on transferring real estate to your children
- Capital gains and taxes when inheriting real estate
- What happens to your TFSA when you die?