Tax and Protection
How to lower your family tax bill using prescribed rate loans
By Erica Nielsen, CPA, CA 26 June 2025 5 min read
High-income earners are often seeking strategies to manage their tax obligations. One of the most powerful approaches is income splitting, a method that transfers income from a family member in a high tax bracket to one in a lower bracket, potentially reducing the family's overall tax bill. While there are several rules that restrict income splitting methods, the prescribed rate loan remains a valuable tool.
As of July 1, 2025, the prescribed interest rate is decreasing from 4% to 3%. This change might present an opportunity for individuals to implement a prescribed rate loan strategy to reduce a family’s tax bill.
How does a prescribed rate loan work?
A prescribed rate loan is a loan with an interest rate equal to the official "prescribed rate" maintained by the Canada Revenue Agency (CRA). The CRA updates this rate quarterly based on yields of Government of Canada treasury bills.
Often called a "spousal loan," the strategy typically involves a higher-income-earning spouse making a loan to their lower-income spouse at the prescribed interest rate. The spouse who borrows the funds can then invest the money. Any investment income earned in excess of the interest paid on the loan is taxed at the lower-income spouse’s more favourable tax rate. This can lead to substantial tax savings for the couple over the long term.
Key requirements for a valid loan
For this strategy to be effective, two conditions must be strictly followed:
- A formal loan agreement: The loan must be properly documented with a promissory note or formal loan agreement.
- Annual interest payments: Interest for each calendar year must be paid by the borrower in full by January 30 of the following year. Missing even a single payment, or making a payment late, can permanently invalidate the income-splitting strategy.
Is this strategy right for you?
Ask your tax advisor for advice about a prescribed rate loan if:
- You and your spouse are in different tax brackets. The highest combined federal and provincial tax rate in Alberta for 2025 is 48%, compared to only 22.5%1 for an individual in the lowest bracket. This strategy yields greater benefits when there is a larger difference between your marginal tax rates.
- You have a significant amount of funds available to invest in a personal, non-registered account.
- Your investment strategy is geared towards a long-term time horizon, typically in publicly listed securities or mutual funds, and is expected to generate returns higher than the prescribed rate.
Implementing the strategy
For new loans: To lock in the 3% rate, a new loan must be entered into on or after July 1, 2025 (until at least September 30, 2025). The rate will then be locked in for the entire duration of the loan.
For existing loans: If you have an existing prescribed rate loan with an interest rate of 1%, 2% or 3%, there is no benefit to refinancing. Your primary focus should be on properly maintaining your existing loan.
Alternatively, if you have an existing loan with a rate of 4% or higher, the drop to 3% presents a potential opportunity to increase your annual tax savings. However, you cannot simply change the rate on an existing loan. To benefit from the lower rate, the existing loan must be repaid, which typically involves selling the investments. This process has several consequences that must be considered:
- It may trigger capital gains, resulting in a tax cost that must be weighed against the future benefits of a lower interest rate. Where a capital loss is realized, the superficial loss rules must be considered.
- If the investments have lost value, the fair market value of the investments may be insufficient to pay off the original loan. In this situation, the debt forgiveness rules may need to be contemplated.
If you wish to consider the repayment of an existing prescribed rate loan, we recommend that you discuss these considerations in further detail with your tax advisor.
Beyond spousal loans
A prescribed rate loan can also be made to a family trust for the benefit of minor children or grandchildren. The investment income earned by the trust can be allocated to the beneficiaries to pay for expenses that directly benefit them, such as private school tuition or fees for extracurricular activities.
However, this is a costly structure to implement and maintain, and consideration must be given to the annual costs of filing tax returns for the trust and children. For these reasons, a larger investment portfolio is generally required to make this option worthwhile.
Furthermore, the impact of Alternative Minimum Tax (AMT) on this specific strategy must be thoroughly considered. While the goal is to transfer income to be taxed at a child's low rate, the AMT calculation can create an additional permanent tax in the trust, reducing the effectiveness of the strategy.
Why not just gift the money?
The "attribution rules" exist to prevent income splitting via gifts to a spouse or minor child. If you gift funds for investment, the income may be "attributed" back and taxed as your own. A properly structured prescribed rate loan is a recognized exception to these rules.
Other income-splitting alternatives
While a prescribed rate loan is a powerful tool, it's one of several strategies that can be used to manage a family's overall tax bill. Depending on your circumstances, you may also consider the following:
- Strategies for income splitting in retirement
- TFSA contributions
- CPP pension sharing
- Pension income splitting
- Spousal RRSPs
- Gifting to adult children for TFSA contributions or FHSA contributions
- Strategic spending: A spouse in a lower tax bracket may be able to invest their entire after-tax income while the higher-earning spouse covers all household costs. This strategy is feasible if the lower-income spouse has their own source of funds, such as from employment or inheritance.
Is it time to act?
Prescribed rate loans offer a compelling opportunity for long-term tax savings, but they require meticulous planning and professional guidance. We recommend discussing your financial situation with your financial advisor, who, along with your accountant and lawyer, can help determine if a prescribed rate loan is the right fit for you.
The federal government has tabled legislation to reduce the lowest federal personal income tax rate from 15% to 14.5% for 2025. At the time of publication, second reading of this legislation was completed in the House of Commons.
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