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Kevin Greenard: Spousal RRSPs benefit both spouses

Is a spousal RRSP right for you? Know the advantages — and rules — for using this financial tool.
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Kevin Greenard

Income splitting is a useful tool that can minimize the taxes you and your spouse pay over your lifetime. The goal for any couple is to have equal incomes in retirement, and many steps can be taken along the way to achieve this. One useful tool is the spousal Registered Retirement Savings Plan (RRSP).

Before we dive into the details, one point to note is that a spousal RRSP may not be necessary for couples with approximately the same annual income. The greater the disparity between incomes with a couple, the greater the benefit you will receive from a spousal RRSP.

For example, if one spouse plans to work longer than the other spouse, the spouse working longer can contribute to a spousal RRSP for a spouse that will retire sooner. After three years have passed, the retired spouse can withdraw the funds without the risk of attribution.

Another example of using the spousal RRSP strategy is when both spouses are retired. Couples can split up to 50 per cent of their eligible pension income, such as RRIF withdrawals or amounts from a registered pension plan.

You don’t need a spousal RRSP to take advantage of income splitting; however, if the higher-income spouse will have other sources of income in retirement that are not eligible to be income split (i.e., dividends from a corporation), spousal RRSPs may be particularly useful. It is important to begin planning today to set yourself up to income split in retirement.

With fewer and fewer income splitting opportunities between spouses, it is important to understand the remaining strategies. Spousal RRSPs are an effective way to split income between spouses during your lifetime. However, it is important that you know the rules.

What is a spousal RRSP?

A spousal RRSP is an account to which you contribute; however, your spouse is the annuitant of the account. This means that you receive the tax deduction for the contribution to the account, but your spouse will receive the proceeds from any withdrawals from the spousal RRSP. Once the contribution is made, your spouse becomes the owner of the funds within the account. It is important to note that the spousal RRSP contributions are based on the higher-income spouse’s contribution room, rather than the receiving spouse’s RRSP contribution room.

The advantages of a spousal RRSP

The biggest advantage of a spousal RRSP is the opportunity to split retirement income between spouses.

Effective retirement planning would result with both spouses having equal income-producing assets at retirement. This would allow the family to take advantage of splitting income instead of having it all taxed in one individual’s hands, which is normally at a higher marginal tax rate.

Most people will not have equal incomes in retirement, so the spousal RRSP is a method to help ensure that you work towards equal incomes in retirement.

Usually, the higher-income spouse (and therefore the spouse likely to have higher assets at retirement) will contribute to a spousal RRSP for the lower-income spouse to allow them to accumulate assets for retirement. When you finally retire, the withdrawals from the spousal account will be taxed in the hands of your spouse, usually at an overall lower tax rate than would be the case if the withdrawal was taxed in your hands.

The advantage to this income splitting strategy is based on the fact that the contributor receives a tax deduction at a higher tax rate than the income will ultimately be taxed at.

Know the rules and be careful of the attribution rules

There are rules in the Income Tax Act called attribution rules that are designed to prevent abuse of spousal RRSPs. The rules state that:

• Withdrawals from a spousal account will be taxed in the hands of the contributor if a contribution has been made to any spousal account in the year of the withdrawal or the previous two years. What this means is that if you made a contribution to any spousal account, you must wait three years before your spouse can withdraw it without it being taxed back to you.

The attribution rules do not apply in the following circumstances:

• If funds are transferred directly for your spouse or common-law partner to a Registered Retirement Income Fund (RRIF) and only the minimum payments are withdrawn, there is no attribution. However, there may be attribution on funds withdrawn in excess of the minimum payment as long as the three years is still in effect. After the three years has passed, there is no further attribution.

• If funds are used to purchase a life annuity or a term certain annuity to age 90.

• If the spouses are living apart due to a breakdown of relationship at the time of payment.

• If either spouse becomes a non-resident of Canada at the time of payment.

• If the contributing spouse dies in the year of payment.

• If the deceased annuitant is considered to have received the amount because of death.

Why should you use a spousal RRSP?

One of the most popular questions relating to spousal RRSPs is, “Can my spouse co-mingle their own RRSP with that of their spousal RRSP that I contribute to?”

The answer is yes, however, once you co-mingle the accounts, they are considered a spousal account and therefore subject to the attribution rules discussed above.

We do not recommend co-mingling RRSP accounts. There are reasons to keep the accounts separate, depending upon your circumstances. Having two plans provides you with extra flexibility with respect to withdrawals. For example, if your spouse was not working and wanted to withdraw funds out of their RRSP, they could withdraw them out of their own RRSP and have the income taxed in their hands. If, however, the funds had been co-mingled and a spousal contribution had been made within the last three years, that income withdrawal would be taxed in the hands of the contributor (higher-income spouse).

If you are at the age where you have only RRIF accounts and are only pulling out the minimum annual payment, then co-mingling the accounts at this stage is normally okay. Should there be a chance that you will need to pull out funds above the minimum annual payment, then it is recommended to open up both a RRIF and a spousal RRIF to maintain the funds separately.

Other factors and looking longer term

In some situations, one spouse may be temporarily out of the workforce and will have significant income in the future. Individuals who own corporations or other assets should seek professional advice to see how a spousal RRSP could integrate into a longer-term plan. Stability of marriage, future inheritances, projected retirement dates, and changes in Canadian tax laws are additional factors to consider.

Kevin Greenard CPA CA FMA CFP CIM is a Portfolio Manager and Vice President with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week at timescolonist.com. Call 250-389-2138, email greenard.group@scotiawealth.com, or visit greenardgroup.com.