Spousal RRSPs are often an overlooked account when in comes to investments or savings for retirement. This is mistake. Spousal RRSPs are one of the most powerful ways that Canadians can achieve income splitting. Let’s dive in.
What are Spousal RRSPs?
A spousal RRSP is similar to a regular RRSP, except that instead of the account being for the beneficiary of the contributor, it is for the benefit of the spouse. The contributor still receives the tax deduction for any contributions made to the account up to their personal CRA limit.
The primary benefits of spousal RRSPs is that a higher earning taxpayer can contribute to the RRSP of the lower income earning spouse or common law partner and claim the tax deduction. When amounts are later withdrawn, they will be taxed at marginal tax rate of lower income spouse.
Pension Splitting Rules
Back in 2007, the government introduced significant tax changes to income splitting rules that allowed retirees the option to allocate up to 50% of their pension income to their spouse on their tax return to help reduce overall taxes. For Canadians that have defined benefit pension plans, this splitting can start at any age once payments from the plan start. For all other pension income (e.g. including RRIF’s and spousal RRIF’s), income splitting can only occur at age 65 or older.
Prior to these new rules, the main way retirees could income split was through spousal RRSPs. Although these changes have cause spousal RRSPs to lose some of their importance, there are still benefits of utilizing them as part of your overall financial plan.
Why spousal RRSPs still make sense?
- Income splitting before age 65 – if you retire early and need income, you could start withdrawals from the spousal RRSP because RRIF income cannot be split prior to age 65.
- Leverage the Home Buyers or Lifelong Learning Plans in your spouse’s name to pay for education or the purchase of a home
- Allows you to continue making RRSP contributions past age 71 if your spouse is under the age of 71. You can continue making contributions on their behalf if you have contribution room
- They can be used for planned leaves (sabbatical or parental leaves) of absence or low income years. With proper planning you can withdraw from spousal RRSP to pay expenses during periods of low income and pay taxes at the rate of the lower earning spouse
- For estate planning, you can make contributions after death. In the year of death, you cannot contribute to your own RRSP, but you can still contribute to a spousal RRSP if your spouse is under the age of 71.
It is important to think ‘outside the box’ when it comes to setting up a spousal RRSP. Some key benefits to remember:
- It creates an additional emergency fund or liquidity for your family
- You can access spousal RRSP funds in a way that make sense from a tax perspective
- It provides you with more flexibility
- It allows for tax efficient retirement income to start earlier than age 65