If you’ve recently come into a large sum of money and you’re in a high tax bracket, taxes can take a serious bite out of your investment income. But there’s a little-known strategy that can reduce your tax bill, with the help of your children.
In this post, we’ll walk through a family trust strategy that shifts dividend income to your kids and potentially saves you thousands in taxes each year.
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The Scenario: High Income, High Tax The Scenario: High Income, High Tax
Imagine you’ve just inherited $1 million and you’re already in the top tax bracket. You invest the $1 million and earn $40,000 per year in dividends.
Unfortunately, nearly $15,144 of that income goes straight to taxes, leaving you with only $24,886 after tax.
But what if your kids, who have no income, could receive part of that dividend income instead?
The Strategy: Family Trust and Prescribed Rate Loan
Here’s how it works:
- Set up a family trust with your children as the beneficiaries.
- Loan the $1 million to the trust, do not gift it. This avoids attribution rules that would redirect the income back to you for tax purposes.
- Charge the trust interest at the CRA’s prescribed rate, currently 2% (but increasing to 3% soon).
This allows the trust to earn income from the investments, pay you the required interest, and allocate the remaining income to your children, who pay little or no tax.
How the Numbers Break Down
- The trust invests the $1 million and earns $40,000 in dividends.
- It pays you $20,000 in interest (2% of $1 million).
- You pay $10,000 in tax on that interest (assuming top tax bracket).
- The remaining $20,000 in the trust is allocated to your two children:
- Each child claims $10,000 in dividend income.
- At their low income level, the tax owed is essentially $0.
So instead of paying over $15,000 in tax like in the original scenario, you now:
- Keep $10,000 after tax from your loan interest
- Your kids receive $20,000 tax-free
- Total after-tax income: $30,000
- Tax savings: Over $5,000
Important Notes
You must charge interest at the prescribed CRA rate and pay it annually to avoid attribution rules.
This strategy works best when your children are over 18 and have little to no income.
It requires proper legal and tax setup, including drafting the trust and documenting the loan.
Final Thoughts
By shifting part of your investment income to your low-income children through a family trust and a prescribed rate loan, you can potentially save thousands in tax, every single year.
It’s a smart, legal way to keep more of your hard-earned money while setting up your family for financial success. If are interested in learning more or need help, visit our website and book a free appointment with us.
