Alex Ghani has always taken a long-term view toward saving and retirement. At the tender age of 33, he established a spousal registered retirement savings plan so, as the higher income earner in the family, he could also contribute on behalf of his wife, Sana.
“It’s a great income-splitting tool for our future retirement income, when it will help keep us in a lower tax bracket,” said Mr. Ghani, now a 38-year-old partner with the chartered accounting firm Prasad Ghumman LLP in Thornhill, Ont.
The spousal RRSP is an underutilized, potentially significant retirement savings strategy, experts say.
“People typically scramble at the end of February to make their RRSP contribution, to the extent they’re making a contribution, and don’t really stop to think, ‘What’s going to be our tax situation when we retire?’ They’re just focusing on today,” said Lorn Kutner, a partner with Deloitte LLP in Toronto.
The spousal RRSP not only provides an immediate tax deduction, and a way for investments to grow on a tax-deferred basis, it can also provide flexibility for income splitting in retirement.
For example, pension income can be split only to a maximum of 50 per cent. So if you’re receiving $1,000 a year in pension income, you can move only a maximum of $500 annually to your spouse. But if you’d managed to make spousal RRSP contributions for several decades, and that money had grown inside the RRSP, that provides the potential for a lot more income splitting, with the additional money coming out of your spouse’s RRSP as their income, Mr. Kutner said.
The spousal RRSP also encourages couples, including those in common-law relationships, to anticipate what their income levels and corresponding tax brackets are going to be in retirement. Typically the higher income spouse will make the contribution on behalf of the partner, allowing for an opportunity to pay a lower tax rate when those funds are ultimately withdrawn, as Mr. Ghani has done.
The spousal RRSP works particularly well for those who are not a member of a pension plan because they are not allowed to split their own RRSP until they are 65 or older, said Cherith Cayford, a facilitator for CMG Financial Education in Victoria. “So if they retire earlier than 65, there’s an opportunity to split some income.”
Conversely, many people are living and working longer, earning income past age 71. RRSP rules state that plans must be terminated by the end of the calendar year in which the plan holder turns 71. Proceeds can then be rolled over into a registered retirement income fund, which requires minimum annual withdrawals starting at age 72. Or they can be invested in a fixed-income annuity.
The spousal RRSP, however, provides the potential for continuing contributions. “I think most people think, ‘Seventy-one, I’m done. I can no longer do contributions.’ [But] as long as your spouse is younger, you can make spousal contributions,” Mr. Kutner said.
And the earlier such contributions are made to a spousal RRSP, the better. “If you start doing this rather late in your RRSP contribution life, then you’re not going to be able to accumulate significant enough assets in your spouse’s RRSP to be able to take advantage of his or her marginal tax rates when they start to withdraw money out of the plan,” Mr. Kutner said.
“So if you’re pretty certain your spouse’s income level in retirement is going to be relatively low, the earlier you start making spousal contributions, the better,” he elaborated.
However, there is a special three-year attribution rule attached to the spousal RRSP that contributors need to understand, or it can catch them off guard. If you make a contribution to your spouse’s RRSP and your spouse withdraws that amount, or a portion thereof, from their RRSP within three calendar years, that withdrawal is treated as income on the contributor’s personal tax return, Mr. Kutner said.
“If I made a spousal contribution to my spouse’s RRSP and I’m in a high tax bracket and she’s in a low tax bracket, CRA doesn’t want her to take it out the next year and be taxed at her rates. This is meant to ensure that you’re doing this within the spirit of the rules, which basically says, ‘This is going to allow income splitting in retirement, not so much in current years,’” he explained.
If, for instance, a $5,000 contribution is made to a spousal RRSP on Dec. 31, 2013, the first $5,000 taken out of the spouse’s RRSP in 2014 or 2015 would be taxed in the contributor’s hands, rather than the spouse’s, because the three calendar years attached to attribution would be 2013, 2014 and 2015. The spouse would then need to wait until at least January of 2016 for the better tax benefit.
But if the spousal contribution was made in January of 2014 – contributions for the previous taxation year can still be made up to 60 days hence – then the three-year attribution rule would apply to 2014, 2015 and 2016, and January, 2017, would be the earliest to avoid attribution back to the contributor.
“If you’re thinking of making a spousal contribution and you have the funds available, it’s probably a good idea to do it by December 31 rather than 60 days past the start of the year,” Ms. Cayford advises.
The only exception to this rule, aside from situations that involve death, is when the taxpayer turns an RRSP into a registered retirement income fund (RRIF) or annuity, with the former requiring statutory annual withdrawals.
A major misperception about the spousal RRSP concerns contribution limits. The eligible amount that can be contributed is based on the contributor’s limits, not the spouse’s, said Robert Snowdon, a chartered accountant in Kanata, Ont.
If, for example, the higher-income earner was eligible to contribute $15,000 to an RRSP, they can apportion that $15,000 any way they wish, to either or both of their own or spousal RRSPs as long as they don’t exceed that limit.
“Be careful not to taint the plans. Keep the spousal contribution plan separate from the plan that the partner contributes to on their own,” said Ms. Cayford. Otherwise, she warned, the high-income earner may end up footing the entire tax bill.
Depending on a couple’s potential retirement incomes, the spousal RRSP could also be an effective strategy to reduce income and therefore also reduce or avoid the Old Age Security clawback, which begins at $70,954 of income and is totally clawed back at $115,716, Ms. Cayford said.
Mr. Ghani said he also views the spousal RRSP’s potential to reduce the OAS clawback he and his wife will eventually face as an important part of their retirement savings strategy.