Take Tax Into Account When Dividing Assets

James Samaroden | March 15, 2023

Divorce or separation can be an emotional and challenging time, and one of the most complicated aspects is dividing assets. Registered investments, such as pensions, RRSPs, and LIRAs, are often a significant part of a couple’s financial picture, and understanding how to divide them can be confusing.

Registered investments have special tax considerations.  More specifically, non-registered accounts and investments like your bank account, a TFSA, or non-registered mutual fund do not require you to pay income taxes when you withdraw funds in the future. However, registered investments, such as pensions, RRSPs, and LIRAs, require income tax to be paid when withdrawn.  That means the future income tax must be addressed when considering how to divide the registered asset.

One option when dividing your family property is to keep a registered asset “intact” by having one person retain ownership. However, in this scenario, the income tax that will be paid in the future should be taken into account. Another option is to transfer part of the taxable asset. The Canada Revenue Agency (CRA) has a form (T2220) to “rollover” part of an RRSP or LIRA from one spouse to the other. Pensions can be divided by the pension authority, or one spouse can “buy out” the other and keep their pension intact.

When dividing a registered asset equally, you don’t have to take the tax into account because both parties are getting the same value. However, when kept intact, the correct amount of notional income tax to deduct is likely somewhere between 18% and 25%. It’s important to note that every situation is different because it depends on what income tax bracket the account holder will be in when they start to draw on the registered investment.

Another tax implication to keep in mind is capital gains tax. If you have a second home or other real estate, the primary residence exemption won’t apply to those other properties. When they are sold, capital gains tax will apply. Capital gains tax will also apply to investment accounts other than RRSPs.

Dividing registered investments in a divorce or separation can be complex and emotional. Understanding the tax implications of each option can help make the process smoother and more manageable. Consulting with a Collaborative Professional can be beneficial to ensure that you make informed decisions that work best for your unique situation.

Filed under: Dividing assets