What is a Spousal RRSP? How You And Your Spouse Can Take Advantage of Rare Tax Gifts
Thursday, November 09, 2023
What is a Spousal RRSP? How You And Your Spouse Can Take Advantage of Rare Tax Gifts
Thursday, November 09, 2023
Nida Shahid
You and your spouse are sitting on a beach in your golden years, sipping margaritas and laughing at the taxman's futile attempts to spoil your retirement fun; does this sound great? Thanks to the Spousal RRSP, you'll have more financial sunshine and fewer clouds on your tax horizon.
What is a Spousal RRSP?
A Spousal RRSP (Spousal Registered Retirement Savings Plan) is a specialized retirement savings account available to married couples or common-law partners in Canada. It's like a financial hug you give your spouse for their golden years.
The account is established in the name of one spouse or common-law partner (the annuitant), but it allows contributions from either spouse.
The key feature of a Spousal RRSP is that it enables you and your partner to split retirement income more efficiently for tax purposes, potentially reducing your overall tax liability during retirement.
As the annuitant, you have control over investment decisions and can withdraw from the account, typically during retirement. Only your spouse can contribute to your Spousal RRSP and, only you, the annuitant, can initiate withdrawals from the Spousal RRSP.
This arrangement provides flexibility and tax advantages for couples planning their retirement savings. And remember, when it comes to taxes, the less you pay, the more you can spend on the important things in life—like retirement cruises and a collection of stylish retirement hats!
How Does a Spousal RRSP Work?
A Spousal RRSP is most effective when there's an income and savings gap within a married or common-law couple.
To explain the concept clearly, consider an example where you are Spouse A, and your partner is Spouse B:
⦿ Spouse A has a high annual income of $100,000 and has saved $300,000 for retirement.
⦿ On the other hand, Spouse B has a lower annual income of $40,000 and saved $50,000 for retirement.
Due to the income difference, Spouse A's retirement seems like a luxurious beach vacation, while Spouse B's is more of a staycation.
However, in Canada, tax rates increase as income rises, meaning Spouse A will likely face higher taxes on their retirement income than Spouse B.
Spousal RRSP Solution
To address the situation, Spouse A decides to play financial matchmaker and sets up a Spousal RRSP for Spouse B.
This involves Spouse A establishing and making contributions to a Spousal RRSP held in the name of Spouse B. Thus, Spouse A commits to contributing $10,000 annually to Spouse B's Spousal RRSP for 10 years.
The Outcome
- With the Spousal RRSP strategy in place, Spouse A and Spouse B are now in a similar financial position for retirement.
- When they retire, Spouse A may have an annual retirement income of $60,000, while Spouse B, thanks to the contributions through the Spousal RRSP, also enjoys an annual retirement income of $60,000.
- Hence, Spouse A and Spouse B will be taxed at lower marginal tax rates, reducing overall tax payments during their retirement years.
In this example, the spousal RRSP has successfully bridged the income gap between Spouse A and Spouse B. Consequently, there is a more equitable distribution of retirement income and potentially lower tax burdens for both partners.
Why Should You Open a Spousal RRSP?
A Spousal RRSP enables married or common-law partners to invest in their shared future jointly. Whether one spouse earns more or less, this specific RRSP offers significant tax-related advantages to both individuals.
Following are a few reasons why you should consider opening a Spousal RRSP:
- Tax Deduction: Contributing to a Spousal RRSP reduces the contributor's taxable income either in the year of contribution or in future years if desired, providing immediate tax benefits.
- Income Splitting: During retirement, couples can withdraw funds from their RRIF or annuity and split the income, helping them pay less income tax collectively.
- Lifelong Learning Plan (LLP): Couples can withdraw up to $10,000 per calendar year, to a total of $20,000, from a Spousal RRSP to finance full-time training or education.
- Contributions after Age 71: While an individual cannot contribute to their own RRSP after turning 71, they can continue contributing to their spouse's Spousal RRSP if their spouse is younger than 71, provided there's available contribution room.
- Tax-Deferred Growth: Investments within the Spousal RRSP, such as stocks and ETFs, grow tax-deferred, benefiting both spouses.
Who Should Consider Income Splitting with a Spousal RRSP
However, you must meet certain criteria to enjoy income-splitting benefits through a Spousal RRSP. These include:
1. Spouse in a Lower Tax Bracket
2. Desire for Flexibility
Spousal RRSP Contributions Rules
However, these contributions use your own RRSP contribution room and do not impact your spouse's or common-law partner's contribution room. Here are some key considerations when making Spousal RRSP contributions:
Ownership and Control
Age and Continued Contributions
For example, if you are over 71 and can no longer contribute to your own RRSP, but your spouse is younger, there's still an opportunity for both of you to benefit.
Regardless of whether you contribute to a regular RRSP or a Spousal RRSP, make sure that you stay within your RRSP contribution limit. Failure to do so can result in potential penalties for over-contributions.
What is the Contribution Limit?
You can calculate this limit based on your earned income from the previous year and any unused contribution room from prior years. You can easily find this limit at the bottom of your most recent Notice of Assessment or Reassessment.
How to Calculate the RRSP Contribution Limit?
The maximum allowable RRSP contribution limit for the year 2023 is $30,780.
To determine your specific Spousal RRSP contribution limit for 2023, you must follow these steps:
- Find your earned income from the previous year. It is listed on your Notice of Assessment.
- Multiply your earned income by 18%.
- Now, compare the result obtained in step 2 with the maximum RRSP contribution limit set for 2023. Your Spousal RRSP contribution limit is the lower of the two amounts.
Example:
If your earned income for the year 2022 amounted to $50,000, your Spousal RRSP contribution limit for 2023 would be $9,140, which is 18% of your $50,000 income.
An important point to note here is that your total RRSP contributions, including contributions made to your personal RRSP, must not exceed your overall RRSP contribution limit.
What is the Contribution Deadline and Timing?
So, don't be fashionably late to the retirement party; the tax collector won't appreciate it. Think of it as an RSVP for your RRSP.
Spousal RRSP Attribution Rule
Spousal RRSPs are primarily designed for long-term retirement savings. They come with a unique feature known as the "three-year attribution rule."
Under this rule, if your spouse decides to withdraw funds from the Spousal RRSP within the current year or the subsequent two years, the tax obligation for those withdrawals falls upon you, the contributor, rather than your spouse.
So, plan those withdrawals wisely because nobody wants a surprise tax bill.
Example
Suppose your most recent contribution to a Spousal RRSP was made in 2022, which is $6000.
According to the three-year attribution rule, your spouse should wait until 2025 before making any withdrawals from the Spousal RRSP.
If a withdrawal occurs within the three-year period (2022 to 2025), the withdrawn amount would be added to your income, resulting in a higher tax liability for you.
So, if your spouse withdraws $8000 before 2025, you will be taxed on the $6,000 portion of the withdrawal, as it represents your contributions made within the three-year window.
Likewise, your spouse will be subject to taxation on the remaining $2,000 of the withdrawal, which exceeds your contributions during the attribution period.
Thus, we can say that the three-year attribution rule serves as a tax safeguard. It ensures that Spousal RRSPs are used for their intended purpose of long-term retirement savings, and any early withdrawals are attributed to the contributor's income, not the spouse's.
Spousal RRSP Withdrawal Rules
Now, let's talk about the rules of the withdrawal game in Spousal RRSP land. Here, your spouse or common-law partner is the designated withdrawal champion. They are the sole individuals authorized to make withdrawals from the account.
Any withdrawal from a Spousal RRSP is treated as part of the account holder's or annuitant's annual income. Consequently, it is taxed according to the account holder's tax bracket.
Furthermore, as a contributor, you must also consider the potential impact of the attribution rule on withdrawals by your spouse made within three years of contribution.
Strategic Timing for Withdrawals
Generally, for all types of RRSPs, it is advised to postpone withdrawals until later in life. This is because many individuals find themselves in lower tax brackets as they age. Being in a lower tax bracket leads to paying less tax on RRSP withdrawals, which benefits your overall retirement financial planning.
Transition to RRIF
Your Spousal RRSP doesn't retire; it transforms into a Spousal Registered Retirement Income Fund (RRIF) when the account holder turns 71. It's like your RRSP's retirement makeover. And guess what? Using an RRIF can be a tax-saving ninja move.
Example
Consider a couple withdrawing a total amount of $12,000 annually ($1,000 per month) from their RRIFs. You will notice how the withdrawal can lead to significant tax savings, as shown in the table below:
| Scenario | High-Income Earner's RRIF Withdrawal | Tax Bracket | Tax Paid |
|---|---|---|---|
| Scenario 1 | $12,000 | 40% | $4,800 |
| Scenario 2 | $6,000 | 40% | $2,400 |
| Scenario 3 | $6,000 | 20% | $1,200 |
| Tax Savings | $1,200 |
In Scenario 1, the high-income earner withdraws the entire $12,000 from their RRIF at a 40% tax bracket, resulting in a tax payment of $4,800.
In Scenario 2, a more tax-efficient approach is taken. The high-income earner withdraws $6,000 from their RRIF, incurring a tax payment of $2,400 due to their 40% tax bracket. Simultaneously, the lower-income earner withdraws $6,000 from their RRIF, benefiting from a lower 20% tax bracket and paying $1,200 in taxes.
The tax savings achieved by adopting this approach amount to $1,200. This demonstrates the advantages of optimizing RRIF withdrawals to reduce the overall tax burden during retirement.
Types of Investments Suitable for a Spousal RRSP
A Spousal RRSP offers a flexible investment platform that allows you to grow various investment options, similar to a regular RRSP. You can hold a diverse range of RRSP-eligible investment products within a Spousal RRSP. These include:
- Stocks (both Canadian and international)
- Exchange-Traded Funds (ETFs)
- Options
- Mutual funds
- Bonds
- Gold and silver bars
- Guaranteed Investment Certificates (GICs)
- Cash
Hence, Spousal RRSP is a versatile tool that allows you to tailor your investment strategy to your financial goals and risk tolerance by choosing from a wide array of investment products.
This flexibility can help you build a well-rounded and diversified portfolio within the tax-advantaged framework of the Spousal RRSP.
Additional Considerations
Transition to RRIF
If you're considering transferring funds from your individual RRSP to a Spousal RRSP in Canada, here's what you need to know:
- Ownership Requirement: To initiate a transfer, you must be the annuitant or owner of both the individual and Spousal RRSPs involved.
- Direct Transfer: To avoid potential tax consequences, you must execute the transfer directly. This means you cannot withdraw money from one RRSP and then deposit it into another RRSP you own, whether it's an individual or Spousal RRSP.
- Transfer Options: It is on you to decide where to transfer your funds. You can directly transfer your personal RRSP funds to either another personal RRSP that you own or to a Spousal RRSP that you own.
- Impact on Funds: When you transfer funds from your personal RRSP to your Spousal RRSP, all the funds deposited into your account will be subject to the regulations governing Spousal RRSPs. This applies even if the money originated from your personal RRSP.
Can Unused RRSP Contribution Room be Used After Death?
In the year of your passing or within 60 days after the end of that year, your legal representative can contribute to your spouse's RRSP following the standard RRSP rules. Furthermore, this contribution can be deducted on your final tax return, potentially optimizing your tax situation after your demise.
Final Say!
Now, you must have realized that a Spousal RRSP isn't just a retirement savings plan; it's your secret weapon against the taxman. It ensures you and your spouse enjoy your golden years without those pesky tax clouds.
So, whether it's sipping margaritas on a beach or collecting stylish retirement hats, remember that with a Spousal RRSP, your financial future shines brighter. It's the retirement plan that says, "Cheers to a tax-light retirement!"
Hi, I Am Mitch Zaba
Over the past 10+ years, we've worked closely with clients showing them how to grow their wealth, pay less taxes and how to create predictable passive income in the stock market.
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