Many couples who have a significant difference in income levels, whether married or common-law, seek strategies to help bridge that gap and save on taxes. The spousal Registered Retirement Savings Plan (RRSP) is a flexible savings option that allows one spouse to share retirement income with their spouse and offers some additional tax savings for the higher income earner. The main strategy when it comes to Spousal RRSPs is to carefully consider the timing of your contributions and withdrawals to avoid paying unnecessary penalties or increased taxes, which we’ll discuss in more detail below.
Who Can Open a Spousal RRSP?
The spouse who has the higher income is the one who initially opens the Spousal RRSP. They then make contributions up to an annual limit based on their high salary. The contribution rules would follow regular Canadian RRSP rules, including contribution carry-overs if you did not meet the limit from a previous year, as well as the March 1st deadline. Any payments made into the Spousal RRSP are tax-deductible.
How to Withdraw from a Spousal RRSP?
Once the account has reached its full potential or your spouse would like to be making withdrawals, the timing is the most important factor. In order to transfer the ownership of the Spousal RRSP from the high-income earning spouse to the lower-income earning spouse, a period of two years must lapse without action on the account. This means that contributions must stop for two years before the other spouse can be using the account.
If two years do not pass, then any withdrawals that are made will count as the income of the person who contributed the money, usually the higher-income earning spouse. This would negate any tax-saving measures the account was designed to provide. If you do allow the appropriate amount of time to pass, then when your spouse goes ahead and makes withdrawals, they will be subject to a lower tax amount based on their lower income.
The Best Time to Use a Spousal RRSP
With the complicated rules around contributions and withdrawals, there is a strategy to make the most of the timing. The later in the year you make your contributions, the less time you’ll have to wait before withdrawal time. For example, if you put money into your Spousal RRSP in March of 2021, you will need to wait until January of 2024 before withdrawals are made. That allows for two full years of no contributions. However, if you had made your contribution in December of 2021, you would also have to wait until January of 2024, which would be nine months less waiting time than if you paid in March. The main recommendation is to make a contribution towards the end of the year, if possible.
Why Use a Spousal RRSP?
The Spousal RRSP may not be the best choice for everyone, but the main benefit is the reduced tax if you and your partner have a large income gap. It’s also a secure way to allocate retirement income for your spouse. There are two specific scenarios where a Spousal RRSP can be more beneficial than other accounts or where pension splitting is not possible.
If your spouse plans to retire early, before the age of 65, they can withdraw money from their account and enjoy their lower tax rate, provided they waited the two full years after the last contribution. Because RRIF income withdrawn before age 65 does not count as pension income, it cannot be split with a spouse. But with a Spousal RRSP, you can avoid that complication. A Spousal RRSP is also a good option to provide an income resource for a spouse that can no longer work due to a disability or health condition.
Is a Spousal RRSP a Good Idea?
Many Canadian couples could benefit from a Spousal RRSP, but it depends on your unique situation and life circumstances. Talking to the Private Wealth Managers at Regan Schiller & Associates can help you develop the best retirement strategy for you and your spouse.
This is a general source of information only. It is not intended to provide personalized tax, legal or investment advice, and is not intended as a solicitation to purchase securities. Regan Schiller & Associates is solely responsible for its content. For more information on this topic or any other financial matter, please contact an IG Wealth Management Consultant.