As promised, we're back to continue the discussion around saving for retirement, this week answering your questions about spousal RRSPs. It's one tool Canadian couples can use to split their income and pay less tax in retirement.
Less tax you say? Now we've got your attention.
What exactly is a spousal RRSP?
Think of a spousal RRSP as an investment account for your spouse's retirement. You'll contribute the money and receive the tax deduction, they'll make the withdrawals in retirement and pay the resulting income tax.
The goal of a spousal RRSP is to help equalize income in retirement. As a couple, you'll pay less income tax overall if you're both in lower tax brackets, than if one of you is in a high tax bracket and the other is in a low tax bracket.
Who should consider using one?
They're typically used by couples with a large gap between their incomes – where one spouse has a high income and the other has a low or no income. Perhaps one spouse is at home with the kids or can't work due to illness. The high income spouse will open and contribute to a spousal RRSP for their low income partner.
Say you make $100,000 a year and your spouse makes $40,000. If you both contribute the max to your individual RRSPs each year you'll be contributing much more as you've got more contribution room (18% of $100,000 compared to 18% of $40,000). At retirement you'll have a large nest egg while you spouse will have a comparatively smaller one. If you both start withdrawing income at a standard rate of 4%, you'll have a significantly higher income and resulting tax bill. If you were both withdrawing from similarly sized nest eggs, your overall tax bill would be lower.
Can I open a spousal RRSP for my common law partner?
Yes! A spousal RRSP can be opened for either married or common law partners.
Who owns the plan, me or my spouse?
This is where we see the most confusion around spousal RRSPs, and understandably so. When you open a spousal RRSP the plan is registered in your spouse's name and belongs to them. They make the investment decisions and are the only one allowed to withdraw money from the plan. You're called the contributor and do just that, make contributions.
How much can I contribute? Will a contribution to a spousal RRSP affect how much I can put in my own RRSP?
The amount you can contribute to all RRSPs in a given year is equal to your RRSP contribution limit. We went over how this is calculated in last weeks RRSP Basics column. Whether you're contributing to your own RRSP, a spousal RRSP, or both, your total deposits can't exceed your contribution limit.
Here's an example: if your contribution limit is $20,000 you could put $20,000 in your RRSP, or $20,000 in a spousal RRSP, or some combination like $16,000 in a spousal RRSP and $4,000 in your own RRSP. You can divide your contributions in whichever way is most tax efficient for you and your spouse. You just can't exceed that total contribution limit of $20,000. It's worth noting here that your spouse's contribution limit is not affected.
What's the Three Year Attribution Rule?
If your spouse withdraws money within three calendar years of you contributing it, that withdrawal will be attributed back to you. This means you'll have to declare the income and pay the resulting taxes, not your spouse.
For example, if you contributed $10,000 in December of 2015 and your spouse takes that money out in 2015, 2016, or 2017, it's attributed back to you and you'll get stuck with the tax bill. If they wait until January of 2018 to withdraw, attribution rules won't apply and the income will be taxed to them. Be mindful of this rule when planning withdrawals!
My spouse is younger than me, can I continue contributing to a spousal RRSP if I'm older than 71?
Good question! This is one of the main advantages of the spousal RRSP. You can keep contributing to a spousal RRSP until the end of the year in which your spouse turns 71, as long as you have contribution room available.
We're hoping to retire before 65, are there any age restrictions on withdrawals?
No. This is another notable advantage of the spousal RRSP. Unlike pension income splitting rules which only allow you to split 50% of your income once you're over the age of 65, you can retire at any age and begin withdrawing from a spousal RRSP.
If you're thinking of retiring early, it's worth considering the income splitting flexibility a spousal RRSP will offer.
Finally, who doesn't need a spousal RRSP?
If you and your spouse have similar incomes this might not be a useful tool for you.
As with any investment strategy, you'll have different factors to consider when deciding what makes most sense for you. This is just a starting point to help you understand the basics.
Remember, the deadline to make a contribution for the 2016 tax year and receive a refund is March 1st.