In this post I’m going to go over the topic of Spousal RRSPs and how they can help you lower your overall tax rate. This is a strategy that I find is not being used enough and is something that many couples (married, common-law, or same sex) should at least take a look at, specifically if there’s a significant difference in their incomes. I will not go through in depth about RRSP, since I’ve already covered that in one of my earlier posts, however, I will just highlight another way to use RRSPs to lower the overall taxes in a household.
What is a Spousal RRSP?
A Spousal RRSP is where a taxpayer is able to make contributions into an RRSP that is held in the name of their spouse. The taxpayer is considered the ‘contributing spouse’, and the taxpayer’s spouse is the owner/annuitant of the plan. Essentially, it’s just an RRSP set up for one spouse (who owns the plan), where the other makes the contributions (the contributing spouse). This does not give the taxpayer (contributing spouse) ownership or any trading power over the plan, rather the annuitant (plan owner) maintains full control of the plan.
This is a form of “income-splitting” that Canadians can take advantage of, by shifting income from a higher income earner, to the lower one. It is a tax planning strategy that allows for both short term and long term tax.
How does it work?
Basically, one spouse will contribute into the Spousal RRSP (owned by the other spouse), but will claim all tax deduction on their own tax return. There is an immediate benefit of the tax deduction for the contributing spouse, which enables the taxes paid in that year to be less. However, there’s also the long term tax benefit in that the withdrawals in future years will be taxable to the non-contributing spouse (the one who owns the plan). In a case where one spouse is likely to have a higher tax bracket than the other before and after retirement, this will allow for less taxes overall to be paid up withdrawal, which generally would be at retirement. This is because tax deductions would be received at a higher tax rate, and withdrawals would be subject to taxes at a lower tax rate.
Contribution Limits:
The total allowable amount that can be contributed into the Spousal RRSP cannot exceed the contribution limit allowable for the contributing spouse, for their own RRSP.
Example – Jason is married to Becky. If Jason has a total contribution limit of $10,000 for the year, he can split this $10,000 up any way he chooses and there is no minimum that is required to be put into either the Personal or Spousal RRSP. Therefore, if he contributes $7000 to his own personal RRSP, that means he is only allowed to contribute up to $3000 into the Spousal RRSP where Becky is the annuitant (anything more than this would be subject to penalty).
One important thing to note is that the contributions made into the Spousal RRSP do not affect the contribution space of the spouse who is the annuitant/owner of the Spousal RRSP. So, using the example above, the $3000 of contribution made by Jason into the Spousal RRSP for Becky would not affect the amount that Becky is able to contribute into her own RRSP.
Perks:
A spousal RRSP is also a great way to defer taxes for someone who is not able to contribute into their own personal RRSP because of their age — i.e. by the end of the year an individual turns 71, the RRSP must be converted into a RRIF and there can’t be any more contributions made into it. As long as the spouse is under the age of 71, there can still be contributions made into the Spousal RRSP, and the tax deductions can be claimed by the higher income spouse.
Withdrawal Restrictions:
hen dealing with withdrawals from Spousal RRSPs, there is something that’s called the ‘3 year attribution rule’ that has to be considered. This is a rule that prevents the higher income spouse contributing into the Spousal RRSP, and then having the lower income spouse immediately (or soon after) withdraw the funds at a lower tax rate.
The 3 year attribution rule states that if the annuitant/owner spouse withdraws money from that Spousal RRSP within that year or 2 years after contributions have been made, then that amount will be taxed in the hands of the contributing spouse. However, any time after that and the withdrawals will be taxed in the hands of the annuitant/owner of the Spousal RRSP.
Example — Jason contributes $3000 into the Spousal RRSP for Becky in June of 2012. If the Becky were to withdraw the funds any time before January 2015, the withdrawal would be taxed in the hands of the Jason, at his tax rate. However, any time after that, the redemptions would be taxed in the hands of Becky.
Creditor Protection:
Since the (receiving) spouse actually owns the plan, the funds deposited by the contributor would be protected from any action taken against them. The only rule for this is that there must be a consistent pattern of the contributor making contributions into that Spousal RRSP which are motivated only for the tax advantages.
This strategy is commonly also used as a means to avoid or reduce clawbacks for government sponsored benefits, such as OAS (Old Age Security). Many couples take advantage of Spousal RRSPs as a retirement planning tool, in the case where one spouse’s income is much higher than the others.
One thing to note is that the annuitant/owner of the Spousal RRSP is still allowed to have their own personal RRSP, and can contribute funds into that plan as well. Also remember, this strategy makes most sense when there is one spouse that is earning significantly more income then the other, to balance it out to pay the lowest tax possible. If both spouses are earning around the same amount of income, then this might not make that much sense.
Tax Planning is an important aspect in the overall Financial Planning process, and it should be implemented in the most efficient and effective way. An Elite level Financial Advisor can help put together a thorough plan that helps in all aspects of your Financial Plan, including Wealth Management and Tax Planning.
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