Let’s face it – we could all use a little tax break now and again.
Fortunately, if you are part of a couple, there are more ways than ever to maximize your income tax savings upon retirement.
Traditionally, one of the main tax strategies for retiring couples involved spousal RRSPs. By contributing to a spouse’s RRSP (registered retirement savings plan), a couple could shift income from someone in a higher tax bracket to someone in a lower tax bracket. By equalizing a couple’s income in retirement, they are able to pay the least tax possible. As well, equalizing income can be an effective way to reduce Old Age Security “clawback.”
Then six years ago, the CRA (Canada Revenue Agency) gave retiring couples another option that left people wondering whether spousal RRSPs were really necessary anymore.
In 2007, retirees became eligible to income split without having to transfer any actual funds to their partner. By using this strategy, 50 per cent of a retiree’s pension can be claimed by their spouse at the time they file their tax return. As well, 50 per cent of any RRSP or RRIF income can be claimed by a spouse, as long as the retiree is over the age of 65.
The new income-splitting rule raised the question: If couples can achieve as much tax savings without transferring funds, is contributing to spousal RRSPs a thing of the past?
According to Marie C. Blanchet, Senior Consultant for National Bank Financial Planning, there are many reasons why spousal RRSP contributions continue to be a good idea when it comes to tax savings.
For one thing, spousal RRSPs allow you to transfer more funds to your partner, says Ms. Blanchet. While only 50 per cent of income can be shared under pension income splitting rules, spousal RRSP contributions allow income splitting of 100 per cent of new RRSP contributions.
“Definitely, being able to income-split with 100 per cent instead of 50 per cent is a huge benefit,” she says.
Also, for couples planning to retire before the age of 65, spousal RRSPS offer some very important tax planning strategies.
“As the average retirement age in Canada is approximately 61… spousal contributions can be used to make up a shortfall during the transition period", says Ms. Blanchet. Retirees can draw from a spousal RRSP to bridge the gap before government pensions begin at age 65, particularly if that spouse is in a lower tax bracket. But be sure to withdraw from a spousal plan at least 3 years after the last contribution in order to avoid any tax consequences to the contributor."
There are also benefits if one spouse is significantly younger than the other. Spousal RRSP contributions can delay the onset of taxes until the year the younger spouse turns 72, says Ms. Blanchet.
In addition, the advantages of spousal RRSPs can be felt beyond tax time.
“Spousal RRSP contributions allow investors to double the amount that can be used under the Home Buyers’ Plan (HBP) if one spouse does not already have $25,000 accumulated in his or her RRSP,” says Ms. Blanchet. “The same strategy can be used for the Lifelong Learning Plan (LLP).”
There can also be a benefit in the event of the death of one partner, says Ms. Blanchet.
“When a taxpayer dies, contributions to his spouse’s RRSP are the only approach available to take advantage of one final deduction and make the most of unused deductions,” she says.
Of course, there are some drawbacks to consider before deciding to contribute to a spouse’s RRSP. The contributing party loses control of the funds, as they can be withdrawn by the annuitant or RRSP owner, says Ms. Blanchet. The contributor also has to accept the fact that those funds would be invested in a manner that reflects the account holder’s personal risk tolerance.
However, despite any potential drawbacks, spousal RRSPs remain a vital element of financial planning, says Ms. Blanchet. “For many investors, these drawbacks pose few problems compared to the benefits derived from contributions to a spouse’s RRSP.”
“In general, spousal RRSP contributions allow clients to simplify any income splitting strategy and consequently reduce their income tax payable without the wealthier spouse being taxed on withdrawals,” she says.
Contributing to a spouse’s RRSP also helps protect against legislative changes that might happen in the future, says Ms. Blanchet, or even the elimination of the current income-spitting regulations.
“What we have in place now is of wonderful benefit to people who are about to retire or who are already retired, but we don’t know what kind of federal budget changes may take place over the next 10, 15, 20 years,” says Ms. Blanchet.
“So people who are saving now for retirement need to be mindful of the fact that we really are trying to put as many strategies in place that will allow as many income-splitting opportunities as possible in retirement.”