You probably already know about the importance of investing in RRSP as a means of saving for your future retirement, and as an effective method to reduce your income taxes. A Spousal RRSP is an effective way to reduce taxes on your retirement savings by redistribtuing the savings (and subsequent pension incomes) between yours and your spouse’s RRSP plans. Spousal RRSPs can reduce your taxes both when you put the money in the RRSP and in the future, when both spouses are retired.
What is income-splitting?
Income-splitting is a way to reduce the total amount of taxes that your family pays, by transferring the income from a person with a higher income to another family member with lower income. This income will then be taxed at a significantly lower rate or not taxed at all.
Other benefits of income splitting
Income splitting also offers the advantage of avoiding the need to repay Old Age Security (OAS) payments back to the government in cases where the income of one spouse is very high. For the 2015 tax year, the OAS program requires partial return of the OAS received as soon as your personal income exceeds $72,809 per year.
How to align the income of both spouses after retirement using a spousal RRSP
The taxpayer has the right to contribute to his or her personal RRSP or a spouse’s RRSP, however the entire amount of the contribution in the tax return will be deducted from the income of the person who made the contribution. The immediate benefit for the investor in RRSP is that their tax payment will go down the same year, and, in the long run, after retirement, their future family taxes will be reduced too. Since 1993, the definition of a “married couple” is based on general family law. If an unmarried couple lives together for one year or more, or lives together and has a common child, they are entitled to contribute to a spousal RRSP.
The total amount of your contribution to the spousal RRSP combined with personal RRSP can not exceed your maximum room of contributions to the RRSP. For example, John makes $50,000 a year. Considering this year’s maximum contribution, which is 18% of the earned income in the previous year, John can contribute $9,000 to his RRSP. He may contribute the whole $9,000 to his personal RRSP or his wife’s RRSP, or split it into two parts for his and his wife’s RRSPs, but the total contribution can not exceed the maximum amount of his unused room from all previous years.
A spousal RRSP can also be used as a way to postpone tax payments. If the person is older than 71 years and continues to work, they are no longer able to contribute to a personal RRSP because of the age limit. If the person’s spouse has not reached that age, that person can contribute to his (her) spouse’s RRSP and thereby reduce their current tax.
It’s important to remember the “three years” rule if your spouse plans to withdraw money from his/her spousal RRSP soon. If the spouse with the lower income who has received contributions to his/her RRSP decides to withdraw funds immediately or within three calendar years after the last contribution, the funds will be taxed at the highest tax rate for the spouse who made the contribution. If the funds are withdrawn after three years after the contributions are made, these funds will be treated as income in the tax return of the person who received the contribution. It is important to remember, that these terms are calculated in calendar years.
For example, if the last contribution was made in December 2012, the money withdrawn from the spousal RRSP will be taxed as the income of the recipient from January 2015. If the RRSP contribution was made in January 2013, even if it was included in the contributor’s tax return for 2013, it will be taxed as the recipient’s income from January 2016.
The “three years” rule does not apply in the following cases:
- The couple divorces, and the spouses are separated;
- One spouse dies in the year when the funds were withdrawn from the plan;
- One of the spouses ceases to be resident of Canada for the purposes of taxation;
- If the money is transferred to an annuity
Note: If you turned your spousal RRSP into a RRIF, you are allowed to withdraw only the minimum amount of money within three years after the last contribution. Any excess of this amount will be taxed as income in the tax return of the contributor, not the recipient.
The Spousal RRSP is one of the few legitimate means for redistribution of income within families that helps Canadians save money, especially when the majority of people need it, namely, during retirement.
Branch Manager, Bloor West
Ukrainian Credit Union Limited