Splitting the difference with spousal RRSPS
They’re handy when one income is larger
It seems with every passing year there’s a new strategy to consider when planning for retirement.
Yet tried and true vehicles such as spousal RRSP contributions can still play an important role in financial planning.
The idea behind spousal RRSPs is simple: One person (usually the higher-income earner) contributes to a plan that is in the spouse’s name. While the tax deduction goes to the contributor, the spouse owns the plan and is responsible for paying taxes when the money is withdrawn.
The original intent of spousal RRSPs was to allow for future income splitting at retirement, says Diane Kirkland, a certified financial planner with Edward Jones Investments in Vancouver. “It was pretty much about building up retirement assets.”
That doesn’t mean spousal RRSPs can’t be used for other purposes.
With some strategic thinking and good planning, they can sometimes play a part in supporting a home purchase or preserving benefits like old age security (OAS) payments.
“People typically use spousal RRSPs when there’s a large discrepancy in income,” says Allan Small, senior investment adviser with DundeeWealth in Toronto.
“The idea is that the funds can be taxed at the spouse’s rate, which could be very low. But they can also be a useful tool at any age.”
While there are clear benefits in reducing taxes and building a nest egg for retirement, there are nuances people often overlook, says Richa Hingorani, regional financial planning consultant for RBC in Toronto.
For example, it could be a way for a person to prolong their deductions as they age. For example, a person over 71 might not be able to contribute to their own RRSP, but can contribute to a spouse’s if the latter is younger. “That can be a huge advantage if you want to [reduce taxes] and continue to build up a retirement allowance,” Hingorani says.
Also, funds from a regular RRSP and spousal RRSP can be combined for a Home Buyer’s Plan or Lifelong Learning Plan.
These plans allow you to withdraw funds from an RRSP tax-free if they are put toward a first-time home purchase or full-time training or education.
The funds must be repaid to the RRSP within 15 years, however, or the remaining portion of the withdrawal will be taxed.
“If you’ve contributed to a spouse’s plan, the advantages can actually be doubled,” Hingorani explains. “With the Home Buyer’s Plan, for example, you could take the $25,000 limit out of each plan to come up with $50,000.”
However, plan owners should be mindful of the three-year attribution rule when considering any withdrawals from a spousal RRSP. It states that if a person withdraws funds within three calendar years of the last contribution, the income will be taxed at the contributor’s rate, not the spouse’s. (One item of note: If you contribute to a spousal RRSP in December, it counts as a full calendar year.)
Because of this rule, it’s important to plan well in advance when considering a withdrawal, whether it’s for retirement or to fund a planned leave of absence or maternity leave, Hingorani notes.
Sometimes the tides of income can shift, and the spouse might make more money further down the road. At that point you may end up with too much in your RRSP and not qualify for OAS, Small says. In that case, he advises depleting the spousal RRSP funds before retirement.
When retirement does come calling, it’s important to factor in all your income resources and needs when talking to your adviser. There are a number of income-splitting options available that can help a couple maximize their returns while minimizing the tax burden.
“The big picture plan that takes into account all aspects is important,” Hingorani says. “A spousal RRSP is just one of them.”
Whatever the strategy, at some point you will have to pay taxes on your spousal RRSP funds, Kirkland notes.
“That’s where you need a financial adviser to determine how your spousal RRSP fits into your overall plan; if it continues to be the right choice; and the best income splitting options for you.”
Diane Kirkland, CFP and financial adviser at Edward Jones, says the original intent of spousal RRSPs ‘was pretty much about building up retirement assets.’