Prescribed Rate Loan

A prescribed rate loan is a tax strategy where a higher-income spouse lends money to a lower-income spouse (or a family trust) for investment purposes. The loan must charge interest at the CRA’s prescribed rate at the time the loan is set up. The key benefit is that investment income earned on the borrowed money gets taxed at the lower-income spouse’s marginal tax rate instead of the higher earner’s rate.

How it works

The higher-income spouse lends a lump sum to the lower-income spouse. The loan agreement must be documented and charge at least the CRA’s prescribed interest rate (which is set quarterly and published on the CRA website). The lower-income spouse invests the money and earns dividends, interest, or capital gains.

The critical rule: the lower-income spouse must pay the interest on the loan by January 30 of the following year, every year, without exception. Miss a single payment and the income attribution rules kick in, meaning all investment income gets taxed in the higher earner’s hands. That defeats the entire purpose.

Why it matters

This strategy works best when there’s a significant gap between spouses’ incomes. If one spouse is in a top tax bracket and the other has little or no income, the tax savings on passive income can be substantial over time.

The prescribed rate at the time the loan is created stays locked in for the life of the loan. If rates are low when you set it up, you keep that low rate permanently, even if the CRA raises the prescribed rate later. This made the strategy especially attractive during years when the prescribed rate was at 1%.

Prescribed rate loans are more complex than most investment strategies and typically involve drafting a formal loan agreement. They work best for families with a meaningful income difference and a large enough sum to invest that the tax savings justify the effort. A spousal RRSP is a simpler alternative for some situations.

A concrete example

Say one spouse earns $180,000 (53% marginal rate) and the other earns $35,000 (20% marginal rate). The higher earner lends $200,000 at the CRA’s prescribed rate of 4%, or $8,000 per year in interest. The lower-income spouse invests the $200,000 and earns $12,000 in eligible dividends. Without the loan, that $12,000 would be taxed at the higher spouse’s rate. With the loan, the $12,000 is taxed at the lower spouse’s rate, and the $8,000 interest payment is deductible. The annual tax savings can run into the thousands.