The Case for Spousal RRSPs

One of the most common questions we receive from clients relates to whether they should contribute to a spousal RRSP, especially in light of the new pension income splitting rules introduced by the Canada Revenue Agency (CRA) a few years ago.  The new rules allow spouses to share up to 50% of eligible retirement income — RRIF, pension or annuity income — with each other. Couples get to choose whether to split the income and, if so, how much to split, when their taxes are filed each year.

Our answer to the spousal RRSP question, like most other financial planning questions, is: it depends!

This note is meant to be a brief primer on spousal RRSPs and how, in some circumstances, they can still play an important role in retirement tax planning.

To begin, here is a refresher on spousal RRSPs and how they work:

• Any Canadian with employment income and who has filed a tax return can contribute to a spousal RRSP for their partner and claim the tax deduction.  Remember though, that your total contributions to your own RRSP and your partner’s spousal plan cannot exceed your annual allowable maximum contribution.
• Once contributed, the money in the spousal RRSP belongs to your partner.  It is therefore taxed as your partner’s income when withdrawn provided your partner does not withdraw the funds within three years of the contribution having been made.
• Since spousal RRSPs let you put assets into your spouse’s name and eventually have withdrawals taxed in their name, they can help to equalize income in retirement.  This can be a key aspect to minimizing taxes.

The new pension income splitting rules made it easier to for spouses to share income in retirement which, in many circumstances, limits the benefits of establishing or contributing to a spousal RRSP. This said, there are still several reasons to consider spousal RRSPs as an effective retirement tax planning tool. You should consider a spousal RRSP if these scenarios apply to you:

You and your spouse expect to retire in different years

Spousal RRSPs may be useful in situations where a still-working spouse has significantly higher income compared to an already retired spouse.

Consider Bill, 65, and Cindy, 70. Cindy built a successful law practice and continues to be actively involved, earning $300,000 per year. Cindy’s RRSP is now worth $1,500,000. Bill retired from his manufacturing position several years ago and now draws a company pension of $50,000 per year. Bill is therefore in a lower marginal tax bracket than Cindy.

Having contributed to his employer’s pension plan throughout his working years, Bill never had an opportunity to contribute to an RRSP and Cindy never considered contributing to a spousal RRSP on Bill’s behalf.

Because Cindy currently only earns employment income (no pension income such as RRIF, pension or annuity), they cannot take advantage of CRA’s income splitting rules. However, Cindy & Bill have missed an opportunity to draw down Cindy’s RRSP assets at Bill’s comparatively favourable tax rate. Had Cindy contributed to a spousal RRSP, Bill could now be supplementing his retirement income with the spousal RRSP assets and paying tax at his relatively favourable tax rate.

Pension income splitting rules may not be enough to equalize and minimize your tax in retirement

Even if you and your spouse are both already retired, a spousal RRSP can be beneficial in minimizing taxes if your retirement incomes are substantially different.

Expanding on our previous example, Cindy, now 72, is semi-retired and earning $100,000 per year from dividends and occasional consulting work. She has also begun to withdraw qualifying retirement income from her RRIF. Upon filing her taxes, she’s chosen to allocate the CRA-mandated maximum of 50% of her RRIF income to Bill, bringing his total taxable income to $75,000. However, even with this additional pension income, the allocation still has not pushed Bill into a higher marginal tax bracket. Bill could still benefit from a spousal RRIF ‘top-up’ of income as he still remains in a lower tax bracket than Cindy.

First-time home buyers should consider spousal RRSPs as well

First-time home buyer rules allow a one-time tax-free withdrawal of $25,000 per person from an RRSP toward the purchase of a home. A little forward planning among spouses can potentially double a couple’s homebuyer draw if the higher income spouse opens and contributes to a spousal RRSP for their spouse if that spouse had yet to accumulate the $25,000 on their own.

These are just a few scenarios under which contribution to a spousal RRSP may still be beneficial despite the introduction of CRA’s pension income splitting rules. One additional factor to be considered when establishing a spousal RRSP is whether the subsequent withdrawals will increase your spouse’s retirement income to a level where their Old Age Security payment could get reduced or entirely eliminated.

If you have questions about whether you should contribute to a spousal RRSP, please call us and we can help determine whether one might be useful to you as part of your long term tax planning.