The Proper Use of Spousal RRSPs
Spousal RRSPs are one of the best income splitting vehicles available to Canadians. Yet, too often, in my experience as a financial advisor, spousal RRSPs are underutilized.
A Spousal RRSP has a number of advantages particularly if there is a significant discrepancy of income between spouses. Let’s look at an example: Mary and Bob. Mary has an income of $65,000 and Bob has an income of $35,000. In this example, if Mary continues to contribute the maximum to her RRSP and Bob contributes the maximum to his RRSP, Mary will have significantly more RRSPs down the road at retirement.
Suppose they have 20 years to retirement, Mary can contribute $11,700 per year to her RRSP and Bob can contribute $6,300 per year. After 20 years, Mary will have almost twice as much in her RRSP ($815,000) as Bob will have in his RRSP ($439,000).
This disparity in assets can easily translate in a disparity of income. The ideal situation for Mary and Bob is to have their RRSP assets split equally ($626,500 each); hence the term income splitting.
In the ideal world, the higher income earner would make the contribution to the lower income earner’s RRSP but still takes the deduction. The lower income earner would then take the RRSP out at some point in the future in a lower tax bracket than the contributor when he/she made the contribution.
Other important issues
1. The definition of a spouse now includes common law.
2. If you are over the age of 69, you can contribute to a spousal RRSP as long as your spouse is not over 69 years of age.
3. The maximum contribution allowed to a spousal RRSP is based on the maximum contribution limit of the contributor. In the previous example, the most Mary could put into Bob’s spousal RRSP is her limit of $11,700.
4. You must be aware of the rules of attribution. The rule of attribution states that if you withdraw money from a spousal RRSP, the contributor will be taxed on the withdrawal if there has been a spousal contribution made in the year of the withdrawal or the two preceding years. For example, if Bob takes money out of the spousal RRSP, this year (2001) Mary would get taxed if ANY contributions were made to ANY spousal plan in 2001, 2000 or 1999.
5. If you are nearing retirement (or a period where the receiving spouse has little to no income), consider making the spousal contributions in December instead of January and February. If Mary made the contribution to Bob’s spousal RRSP in December 2000, Bob could take money out of the Spousal RRSP as early as January 2003. However, if Mary made the contribution only one month later in January 2001, Bob would have to wait a full year in January 2004 to avoid the attribution rules.
6. Finally, it is more important to look at disparities in tax brackets than disparities in income. For example, if Mary’s income was $55,000 and Bob’s income was $35,000, there would be a significant difference in income but they would both be in the middle income tax bracket. The spousal RRSP has more merit when there is differences in tax brackets at the time of contribution and the time of withdrawal.
Proper income splitting requires good preparation and planning. Too often, I see couples nearing retirement realize that they should have made spousal contributions much earlier. Take the time to make some projection and do not be afraid to solicit the help of a financial advisor.