4 reasons spousal RRSPs still make tax sense
Recent income-splitting measures don't negate the need for spousal RRSPs, experts say
The federal government has enacted a number of income-splitting and pension-sharing arrangements in recent years so that retired Canadians can share their income with their spouse or partner and therefore pay less income tax.
For instance, it's been possible to share Canada Pension Plan retirement benefits for more than a decade. The splitting of eligible pension income was introduced back in 2007.
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And last fall, the government introduced the family tax cut, which allows two-parent families with at least one child under 18 to shift up to $50,000 of income from one spouse to the other.
All of these measures have led some people to question whether it still makes sense to use an even earlier income-splitting measure – spousal RRSPs.
Well, the experts have an answer to that question. They all agree that, depending on the circumstances, a spousal RRSP can still offer potentially lucrative tax benefits for some couples.
The idea behind all income-splitting measures is to shift income from a family member in a higher tax bracket to a family member in a lower tax bracket. The family tax cut, CPP sharing and pension income splitting allow for this, as does a spousal RRSP.
Spousal RRSPs allow the high-earning individual to contribute to their spouse's RRSP but claim the deduction themselves. When it comes time to withdraw the funds from the RRSP, the money is taxed in the hands of the spouse, as long as the contribution has remained in the plan for at least two calendar years after the year in which it was first deposited. So, setting up a spousal RRSP can be a good idea if your spouse or common-law partner is likely to be in a lower tax bracket than you in retirement.
Here are four situations in which a spousal RRSP can still provide a substantial benefit to taxpayers:
- You want to retire before age 65 — Pension splitting comes with age limitations that can make spousal RRSPs atractive. For instance, you have to be 65 or over to split RRSP or RRIF income. So, couples under 65 who want to retire early would be real beneficiaries from a spousal RRSP. Pension income-splitting rules also limit the splitting to 50/50. A spousal RRSP results in 100 per cent of the withdrawals being taxed in the hands of the spouse in the lower tax bracket.
Consider contributing to a spousal RRSP in December rather than the following January. A contribution made in December 2014, for instance, would have allowed withdrawn funds to be accessed in 2017 and taxed in the hands of the lower-income spouse. But if the contribution had been put off a month until January 2015, the funds could not be accessed on a tax-advantaged basis until 2018.
- One spouse is older than 71 — Normally, you can't contribute to an RRSP in the year after you turn 71 even if you're still working. But if you have a spouse who is 71 or under, you can contribute to a spousal RRSP and still reap a tax break. As long as people have earned income from the previous year, this can be a smart move for those over 71 who have younger spouses.
- You're saving to buy your first home — A spousal RRSP can allow both spouses to access RRSP funds to purchase a home. Under the Home Buyers' Plan, a first-time buyer can withdraw up to $25,000 tax-free from their RRSP to help them buy a home. A spousal RRSP can allow the other spouse — even one who doesn't work outside the home — to access another $25,000 in funds for the same purchase.
- One spouse wants to take a year off to have a child — Let's assume that a couple is planning to start a family a few years from now. The higher-income spouse can contribute to a spousal RRSP and get a tax break worth up to 45 per cent of the contribution. Then, assuming the three-year non-contribution period has been satisfied, the lower-income spouse can withdraw those funds and pay little or no tax. "This may be particularly advantageous in providing additional family funding when a lower-income spouse takes time off work, perhaps to raise children or start a business that isn't expected to earn profits for a number of years," says the accounting firm KPMG. It adds an important warning: unlike tax-free savings accounts, funds withdrawn from a spousal RRSP can't be recontributed to the plan at a later date without drawing down on future contribution room.
The experts say it's best to use tax software programs (or hire a tax professional) to figure out if any income-splitting or other sharing manoeuvre makes financial sense. That's because these type of moves have the potential to affect a whole range of other things, like Old Age Security clawbacks and the age amount tax credit. Tax software can optimize tax savings by suggesting the best method of splitting income.
Tax experts also say pension income splitting and spousal RRSPs are not either/or things. "Depending on your personal situation, the strategies can be combined in a manner to produce the most effective financial and tax results," notes Ernst & Young in the firm's online Managing Your Personal Taxes publication.