Spousal RRSPs

In this post I'm going to go over the topic of Spousal RRSPs and how it can help you lower your overall tax rate. This is a strategy that I find is not being used enough and is something that all couples should at least take a look at. I will not go through in depth about RRSP, since I've already covered that in one of my earlier posts, however, I will just highlight another way to use RRSPs to lower the overall taxes in a household.

What is a Spousal RRSP?

Essentially, it's just an RRSP set up for one spouse (who owns the plan), where the other makes the contributions. This is a form of "income-splitting" (which I discussed in my previous post) by shifting income from a higher income earner, to a lower one, so that the total income between the two will be taxed at a lower rate overall.

Note: common-law partners are also able to take advantage of this plan.

How Does it work?

Basically, one spouse will contribute into the the RRSP of the other spouse, but will claim all tax deduction on their own tax return. There is a immediate benefit of the tax deduction for the contributing spouse, but also the long term overall benefit will lower the tax bill for the both of them as they will be able to withdraw more funds at a lower tax bracket in their later years.

Contribution Limits:

The total RRSP contribution for 1 spouse (for both the personal RRSP and the amount contributed into Spousal RRSP) cannot exceed the Personal RRSP deduction limit for the contributing spouse.

Example -- If the husband has a total contribution limit of $10,000 for the year, and he contributes $7000 to his own personal RRSP, that means he is only allowed to contribute up to $3000 into the Spousal RRSP (anything more then this would be subject to penalty). This $10,000 can be split up any way and there is no minimum that is required to be put into either the Personal or Spousal RRSP.

Perks:

A spousal RRSP is also a great way to defer taxes for someone who is not able to contribute into their own personal RRSP because of their age -- i.e. at age 71, the RRSP must be converted into a RRIF and there can't be any more contributions made. As long as the spouse is under the age of 71, there can still be contributions made into the Spousal RRSP, and the tax deductions can be claimed by the higher income spouse.

Withdrawal Restrictions:

When dealing with withdrawals from Spousal RRSPs, there is something that's called the '3 year attribution rule' that has to be considered. This is a rule that prevents the higher income spouse contributing into the Spousal RRSP, and then having the lower income spouse immediately (or soon after) withdraw the funds at a lower tax rate.

The 3 year attribution rule states that if the lower income spouse withdraws money from that Spousal RRSP within 3 calendar years of it being contributed by the higher income spouse, then it will be taxed in the hands of the higher income spouse. However, if it is more then 3 calendar years after the contribution, then it is taxed to the lower income spouse.

Example -- Husband contributes $3000 into the Spousal RRSP in June of 1998. If the wife were to withdraw the funds any time before January 2001, they would be taxed in the hands of the husband. However, any time after that, and they would be taxed in the hands of the wife.

Creditor Protection:

Since the (receiving) spouse actually owns the plan, the funds deposited by the contributor would be protected from any action taken against them. The only rule for this is, that there must be a consistent patter of the contributor making contributions into that Spousal RRSP which are motivated only for the tax advantages.

This strategy is also used for OAS (Old Age Security) Calculations. To avoid clawback, many couples do this in retirement in the case where one spouse's income is a lot higher then the others.

One thing to note that one spouse is still allowed to have a Personal RRSP even if the other is contributing into a Spousal RRSP. Also remember, this strategy makes most sense when there is one spouse that is earning significantly more income then the other, to balance it out to pay the lowest tax possible. If both spouses are earning around the same amount of income, then this strategy probably would not make that much sense.

I hope you've learned something from this post and if it makes sense for your situation, please use it, because it will keep more dollars in your pocket. Please also consult your financial advisor before making any decisions, and if you have any questions or require further information, please do not hesitate to contact me.