Spousal RRSPs help couples save by sharing

By making post-retirement income streams as equal as possible, couples can reduce their tax burden.

Matthew Elder 8 February, 2016 | 6:00PM

Sharing is an important part of a marriage, and this often means pooling income and combining assets for practical purposes. But when it comes to good tax planning, an important strategy is to "split" -- not physically, but in terms of how you report your income to the tax man. Determining who has the higher income, who holds investments (both income-generating and capital-gains producing), and who pays most of the bills can have a significant effect on your combined overall income-tax bill -- both now and in the future.

For example, depending on circumstances, it may make sense for the higher-income spouse to pay household expenses, and for the lower-income spouse to channel his or her earnings into investments. There are other more complicated income-splitting strategies, many of which must heed the general anti-avoidance rules. But when it comes to long-term financial planning, one of the longest standing and most effective tactics is the spousal registered retirement savings plan.

A spousal RRSP enables one spouse to contribute to the other's plan, and claim the related deduction on his or her own tax return. (Your contributions to a spousal RRSP do not affect your spouse's own RRSP contribution room. He or she can contribute each year to his or her maximum limit as well.)

Save on taxes now -- and later
Contributing to a spousal RRSP offers two advantages: the contributor gains a valuable tax deduction, and the recipient can build his or her own RRSP savings. The post-retirement goal is two fairly equal nest-eggs. In theory, equalization will result in a lower combined income-tax bill when the money is withdrawn through a registered retirement income fund (RRIF) or a registered annuity. (RRSP savings -- both investment capital and income -- are fully taxed upon withdrawal.)

For example, if your earned income in 2014 was $80,000, you would be entitled to contribute up to $14,400 to your own RRSP and/or to a spousal plan. If your spouse's income was $40,000, his or her own RRSP limit would be $7,200, which could also be contributed to his or her plan.

At retirement time, the result ideally will be two streams of income that are taxed at a lower rate than if most of the income had been taxed in the higher-income spouse's hands -- or at the least some of that income could be taxed in the hands of the lower-income spouse.

Reduce or eliminate the OAS clawback
Spousal RRSPs and other effective income-splitting strategies also may help eliminate or reduce the amount of Old Age Security income that is clawed back based on your income. At present, anyone with income in excess of approximately $71,000 must repay at least some of his or her OAS benefits. Above that threshold, the greater your income, the greater the clawback will be. At about $115,700, all of your OAS must be returned to the government.

Double-up on the Home Buyers' Plan
Another good use of a spousal plan is to create two pools of RRSP savings to double-up on use of the RRSP for a Home Buyers' Plan. The HBP allows a first-time buyer to withdraw up to $25,000 tax-free from an RRSP as a down payment. A spousal RRSP can allow the other spouse to access another $25,000 in funds for the same home purchase. The HBP is available if you or your spouse hasn't owned a home as your principal residence in any of the five calendar years, up to an including the present year.

Contribute to a younger spouse after age 71
If you are older than your spouse, you may continue making tax-deductible contributions to a spousal RRSP after the year in which you turn 71, the normal deadline for collapsing an RRSP. You can keep on making spousal contributions until the end of the year in which the recipient spouse turns 71.

Common-law spouses are also eligible
You don't have to be legally married to contribute to a spousal RRSP. In 1993, the definition of spouse for taxation purposes was changed to include common-law spouses, which the Canada Revenue Agency considers to be a conjugal couple who have lived together for one year or more. If you are divorced and share custody and support of your ex-spouse's children, you may use the spousal RRSP. And if you are single, you still may make spousal RRSP contributions for someone with whom you had have a child together by birth or adoption.

Heed the three-year attribution rule
Money contributed to a spousal RRSP is subject to a three-year attribution rule. This prevents the higher-income spouse from contributing and then withdrawing the funds soon after at the spouse's lower income-tax rate. If a contribution is withdrawn from a spousal RRSP during the calendar year that the contribution was made -- or in the two subsequent calendar years -- the contributing spouse would have to pay tax on the amount withdrawn. For example, if your last contribution to a spousal RRSP was made anytime during 2014, your spouse would have to wait until January 2017 to be able to withdraw that amount at his or her tax rate.

The three-year attribution rule does not apply if:

  • You and your spouse are living apart due to marriage breakdown;
  • The contributing spouse dies in the year a withdrawal is made;
  • Either spouse becomes a non-resident of Canada (as defined by taxation laws);
  • The money is transferred to an annuity. (However, if the amount is transferred to a RRIF, it would be subject to the minimum withdrawal rules until three years after the last spousal-RRSP contribution. Any withdrawals above the minimum will be taxed as income on the contributor's tax return.)

What happens if the relationship ends?
The money in the spousal RRSP belongs to the recipient spouse, but under provincial separation and divorce laws (family patrimony in Quebec) you generally would have to divide assets equally. If you are living common-law, consider drafting a joint agreement to cover the spousal RRSP; depending on the province, assets may have to be divided equally.

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Matthew Elder

Matthew Elder