The Spousal RRSP – One of the Most Overlooked Strategies!

A Spousal RRSP is an account that is used for future income splitting purposes. If you are a regular reader of this blog, you will know that it makes great sense to equalize income between spouses in order to reduce household taxes as much as possible – this is due to our progressive tax bracket system.

The lack of use of spousal RRSP’s is one of most overlooked financial planning strategies I encounter on a regular basis – and it is almost imperative that you set one up if your current planning strategies do not allow for equal income in retirement between spouses. (If you are wondering about the new pension income splitting rules – don’t worry, it still makes sense to set up spousal RRSP accounts and I’ll explain why in a post in the next few days.)

WHAT IS A SPOUSAL RRSP?

A Spousal RRSP account is an RRSP account that a higher tax bracket spouse (the contributor) deposits funds to, but once deposited, the funds belong to the annuitant (your spouse or common law partner who is currently in a lower tax bracket). The contributor claims the income deduction now, but withdrawals are taxed in the hands of the annuitant (except in a few particular situations outlined below).

WHY WOULD YOU USE A SPOUSAL RRSP?

The short answer is that it provides for a mechanism to equalize retirement income down the road. If you are both claiming an equal amount of income in retirement, you are almost certainly paying the least amount of taxes as a household unit as possible.

EXAMPLE OF INCOME SPLITTING

If one person had a gross income of $100,000 in 2007 they would pay about $28,961 in income tax (Ontario). If that income were split between two spouses with each having a gross income of $50,000 – then each are paying $9,915 per year in income taxes for a grand total of $19,830.

Hmmm… $28,961 in tax vs $19,830 in tax… That is a difference of almost $10,000! Multiply that by a 30 year retirement and you are looking at $300,000 in taxes that didn’t have to be paid. So you can see, it is not a subject to be taken lightly.

WHAT IS THE DIFFERENCE BETWEEN A CONTRIBUTOR AND AN ANNUITANT?

Contributor: The person making the contribution of funds to the spousal RRSP account (the higher income spouse).
Annuitant: The person who owns the spousal RRSP (the lower income earning spouse). Withdrawals from the account are taxed in their hands (except in certain situations as noted below under the Three Year Rule).

Generally speaking, if you have one spouse in a higher tax bracket during the working phase of life they would make a contribution to their spouse’s spousal RRSP account if it was necessary to allow for income equalization in the future. In other words, it is not necessary to set up a spousal RRSP account just because two spouses are in different tax brackets. For example, it is possible that a higher earning spouse has no pension, but the lower income spouse has a great pension. In this case, it might be better for the higher income spouse to just contribute to their own RRSP so that their RRSP/RRIF income will be approximately equivalent to the other spouse’s defined benefit pension income. Remember: the goal is income equalization.

The reason you use spousal RRSP accounts is so that the contributor to the spousal RRSP would claim the contribution as an income deduction on their own taxes (being in a higher tax bracket) and at the same time allow for the lower income earning spouse to build up their retirement income for the future. If the lower income earning spouse just contributed to their own account, the tax refund would be less even though the contribution would be the same.

It makes no difference to the contributor as to which account they contribute to from an immediate tax refund point of view. No matter how they allocate their contributions, the amount of tax relief they generate is the same if they made their contribution to their own RRSP or to a spousal RRSP or any combination in-between.

CONTRIBUTION LIMITS

The contributor is limited to how much they can contribute to RRSP’s (their own or spousal RRSP’s) according to the same rules as usual. So, if they had $5,000 in RRSP contribution room they could elect to: A) Contribute $5,000 to their own RRSP; B) Contribute $5,000 to a spousal RRSP; C) Contribute $2,500 to their own RRSP AND $2,500 to a spousal RRSP; D) Any combination of contributions to both accounts so long as the total RRSP contribution made is within their limit. In other words, there is no extra RRSP contribution room allowed for making a spousal RRSP contribution.

THE THREE YEAR RULE

Any withdrawals from a spousal RRSP account are taxed in the hands of the annuitant BUT THERE ARE SOME EXCEPTIONS TO THIS RULE. The Three Year Rule states that contributions that are subsequently withdrawn during the same calendar year, or the following TWO calendar years, are taxable in the hands of the CONTRIBUTOR. This rule was designed to ensure that a high income earner would not set up a spousal RRSP account solely for the purpose of reducing taxes now by making the contribution (and claiming the deduction) and then withdrawing the money immediately from the spousal RRSP in the lower tax bracket annuitant’s hands.

Senior_citizens_free.jpgAlso, even though the contributor can claim a deduction for making a spousal RRSP contribution in the first 60 days of the following tax year, note that the Three Year Rule applies for the calendar year you make the contribution, NOT the tax year you claim the deduction. In other words, if you made a spousal RRSP contribution on Dec 31st, 2007 you could indeed withdraw the money and have it taxed in the lower tax bracket annuitant’s hands if you wait until Jan 1st, 2010. BUT, if you waited one more day to make the contribution on January 1st of 2008, even though you could still claim the deduction for the 2007 tax year, you could not claim the withdrawal in the lower tax bracket annuitant’s hands until January 1st, 2011.

EXCEPTIONS TO THE THREE YEAR RULE

Their are some exceptions to the three year rule:

1. The money is transferred into an annuity.
2. Spouses are living apart due to a breakdown in the relationship.
3. The contributor dies in the year of the withdrawal.
4. EITHER spouse ceases to be a resident of Canada for tax purposes.
5. You convert your spousal RRSP into a spousal RRIF which is subject to minimum withdrawals. In this case, only the amount of the withdrawal within the Three Year Rule’s range that is OVER the minimum annual withdrawal required for a RRIF account is subject to attribution back to the contributor.

FINAL THOUGHTS

Retirement income equalization is one of the most overlooked areas of personal finance – don’t take it lightly. It should be an integral part of your financial planning from the get go – no matter how far off the goal line is. I’ve had some clients take me aside and express that they have doubts about the long term nature of their marriage and wonder about holding off on the strategy – don’t worry, just do it. Division of property upon relationship breakdown almost always includes your future retirement income anyways, and if you hold off and your spouse finds out why – you may just solidify the dissolution of your relationship! That’s a type of income splitting you want to avoid!

It should also be noted that the investments inside a spousal RRSP account need to fit the risk tolerance and time horizon, etc. of the annuitant – not the contributor. So if you think that just because you make the contribution, you have the final say on what the investments are – “technically” you don’t – although this doesn’t tend to matter to people much. But remember, “technically” the funds belong to the annuitant. Make sure you both understand this ahead of time.

Preet Banerjee
Preet Banerjee
...is an independent consultant to the financial services industry and a personal finance commentator. You can learn more about Preet at his personal website and you can click here to follow him on Twitter.
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Showing 19 comments
  • Traciatim

    One thing that confuses me here, does the annuitant have to have any income at all? For instance in a single income household could all RRSP contributions be split 50/50 between each spouse so that in retirement their incomes would be nearly equal?

  • Preet

    Traciatim – yes absolutely correct. There is no requirement for the annuitant to have an income.

  • L.

    Just a question.
    If a spousal rsp receipt is issued in the name of the annuitant stating the contbributor sin and name, but now both sin’s are stated, can the annuitant elect to use this receipt for them if the contributor has discovered they are already contributed in their own rsp to the limit? Thanks,

  • Preet

    Hi L., if the official tax receipt from your spousal RRSP plan provider shows the contributor’s name on it, then they will have to claim the contribution. Note that if the contributor has already maximized their RRSP, then you have a few options:

    1. You can use the $2000 overcontribution limit to avoid the 1%/month penalty.

    2. If the contribution was made in the first 60 days of this year, you don’t have to claim the contribution for last year, you can claim it for the 2008 tax year on next years tax return. I’m not actually 100% sure, but I don’t believe you will incur the overcontribution penalty this way – best to check with an accountant to be on the safe side.

  • Peter

    I have a question about the three year rule for a spousal RSP.

    I last contributed to one of my spouse’s RSPs 10 years ago and haven’t contributed to that particulat RSP account since.
    I am now contributing to a different spousal RSP account of hers, at a different financial institution.
    If she withdraws funds from the 10 year old RSP plan, is it taxable in her hand or in mine?
    Thanks

    • Preet

      @Peter – it will be attributed back to you to the best of my knowledge. Best to get confirmation from a tax professional though… Thinking is that on the tax forms, there is no differentiation as to which accounts get the contribution (just that it is a spousal RRSP) and which accounts source the withdrawals (again, the forms only see it as if it is from a spousal RRSP, not “which” spousal RRSP).

  • Peter

    hi, my friend told me this, can u tell me if its true. His wife doesnt work, he works, so he bought rsp for his wife $15000, and that year he got back $7500 in returned, and in 2 years plus 1 day his wife can take out the $15000 in rsp without paying any taxes, is that true? will she have to pay that back in rsp? and so on he keeps doing that. thanks.

    Peter

    • Preet

      @Peter – sorry for the delayed response, however your question is fully answered in the post.

  • Miladin

    Hi, Preet,

    You mention: “there is no extra RRSP contribution room allowed for making a spousal RRSP contribution.” This also applies to the annuitant, right? If my wife has a $3000 contribution limit this year and contributes $3000 to her regular RRSP, plus, she has another RRSP (a spousal one, this time) to which I contribute $3000, she’s well over her limit, right?

    Thanks,
    Miladin

    • Preet

      @Miladin No, she’s fine. RRSP contribution room is an individual thing, but you can use it to contribute to your own RRSP or a spousal RRSP belonging to your own spouse.

  • Sonya

    Hi Preet,

    I contributed to my own spousal RRSP in sept 2010 even though i am the annuitant. the receipt has come with my spouse showing as the contributor ( since he is written as the contributor on the account). Is there any way I can claim it for myself still? the company i invested with initially said that it doesn’t matter who claims it as long as both names are on the receipt but now i know that is not true. What can I do in such a situation?

    • Preet

      Hi Sonya, sorry for the delayed response! The company should be able to amend the contribution receipt if they indicated that this was allowable, but normally you will need to make a contribution to your own non-spousal RRSP. Remember that you can carry forward claiming the deduction for the already made contribution if an increase in the tax bracket of the contributor is expected in the near future.

  • Fred from Calgary

    Hi Preet, Veeerrry interesting articles, thanks for all the work that you’ve done for ‘us’, your readers.
    My question: What would be your advice with regard to purchasing a rental property as an investment, (house, SxS, etc), so, one would take out a loan or mortgage, (possibly, interest only), buy a house, collect the rent, pay off the house, melt down the rrsp, etc. Or, the rent would pay the principal portion of a mortgage, RRSP withdrawals to pay the interest. The house would eventually be clear title and resulting in a nice cash stream.

    Second quiry: how would our spousal rsp and my reg rsp get ‘pooled’ so that we could have one big meltdown; how would one need to be on title so as to have the taxes done properly, etc.

    I am currently retired with a DB at 57 years, will not pull from rsp for 15 years. Wife works.

    Yes, quite complicated, I know. Thanks for the time and advice, if you deside to tackle this one. It would make a very good article, don’t you think?

    Keep smilin’, Fred

    • Preet

      Hi Fred,

      From a tax perspective the writing off of interest on the investment loan is a separate issue from the tax owing on deregistered funds from an RRSP. It won’t matter where you pull the deregistration of funds from (your RRSP or spousal RRSP) as each dollar, no matter the account source, will be seen as ordinary income. So if the tax saved on the loan interest is equivalent to the tax owed on the deregistration of RRSP funds, they’ll cancel out.

      As for the overall strategy, as always I just suggest that you take time to understand the risks. An interest only mortgage is riskier than paying down the principal. Also, note that all the calls of a frothy real estate market in Canada means you should project how the strategy fairs IN CASE there is a real estate correction in Canada – to at least manage your expecatations.

      Hope this helped a bit.

  • Mark Spurrell

    Hi Preet,

    I have a question regarding contributing to a spousal RRSP. I can contribute to a spousal RRSP based on my deduction limit. I get the deduction and the plan belongs to my spouse. I understand this; however, if my spouse wanted to make RRSP contributions, can she make them to this spousal RRSP as regular contributions from her?

    Thanking you in advance,

    Mark

    • Preet

      Always best to double check with your plan administrator, but generally in my experience your spouse would have to contribute to his or her own non-spousal RRSP as administratively, when they deposit money and issue a receipt, whomever is listed as the contributor on the form you signed to open up the account is the name on the tax slip.

  • Donna

    Hi Preet.
    Husband passed away in 2011. It is my understanding that as Executor of his estate that I can make an RRSP contribution on his behalf into my spousal RRSP in an amount up to his max 2011 deduction limit. However, if he has Unused RRSP limits carried forward, can I make additional RRSP contribution to my spousal Plan or is that amount lost on death?

  • jer

    If someone is 72 and already converted their RRSP to a RIF but is continuing to earn income, is it possible to contribute to a spousal RRSP of a younger spouse?