Spousal RRSPs: Tax-smart retirement planning

Jacob and Jennifer are married and both in their mid-50s. Jennifer has significant registered and non-registered assets and a lucrative pension plan. Her income is over $200,000. Jacob does part-time gig work, is not incorporated, earns significantly less than Jennifer and has no pension plan or retirement savings.

A spousal Registered Retirement Savings Plan (RRSP) can be a great income splitting tool and tax management strategy for Jacob and Jennifer. If Jennifer contributes to a spousal RRSP in this scenario, she not only receives a tax deduction this year, but could be a tax-smart choice for the future.

A spousal RRSP makes sense for a couple of reasons. First, due to Jennifer's current tax rate, the deduction is more valuable to Jennifer than to Jacob. That is, it makes more sense for Jennifer to contribute to a spousal RRSP for Jacob, rather than for Jacob to simply contribute to an individual RRSP for himself. And second, the subsequent withdrawals in retirement will be taxable in Jacob’s hands. This is desirable given that Jennifer already has a pension and significant retirement savings, RRSP withdrawals in her hands would be subject to a higher tax rate. On the other hand, given that Jacob has no other sources of retirement income, RRSP withdrawals in his hands should therefore be taxed at a lower rate.

One of the keys to a successful retirement plan is effective tax management and planning. However, what made sense from a tax-planning perspective pre-pandemic could be very different today. The use of spousal RRSPs present a unique opportunity in this sense, providing a vehicle for additional tax savings for Canadian couples

What is a spousal RRSP?

A spousal RRSP is a special type of RRSP for common law or legally-married partners where one spouse contributes, and the other spouse withdraws. As with an individual RRSP, the person who contributes is entitled to a tax deduction upon contribution. However, with a spousal RRSP, it is not the one who contributed to the plan, but the other spouse who withdraws from it that is taxed on withdrawal. This is the essence of the income-splitting strategy with a spousal RRSP — one spouse earns the deduction upon contribution, while the other spouse pays the taxes upon withdrawal.

Who can open a spousal RRSP?

Spousal RRSPs can be opened by common law partners or legally-married spouses. Unlike a Tax Free Savings Account (TFSA), which cannot be opened until the age of majority, CRA does not specify a minimum age limit for RRSPs or Spousal RRSPs¹ . However, there is an upper-age limit for RRSPs and spousal RRSPs: the account must be closed by December 31st of the year in which the plan holder (the non-contributing spouse) reaches age 71. Just as an RRSP can be transferred to a Registered Retirement Income Fund (RRIF), a spousal RRSP can be transferred to a spousal RRIF upon maturity.

1 – Please note that you must be the age of majority to open an RRSP or Spousal RRSP at Edward Jones.

Why would couples use spousal RRSPs?

The primary reason to employ a spousal RRSP is for income splitting purposes, with the intention of achieving an overall tax savings between two partners where one has a higher income than the other. More precisely, it is used to direct retirement income away from the higher income partner and toward the lower income partner. Of course, all the other reasons to open an RRSP, such as receiving an immediate tax deduction, enjoying tax-sheltered investment growth, and building retirement savings, apply equally to individual RRSPs and spousal RRSPs. But the key distinction is to split income, and reduce tax in retirement, at the household level.

Ownership and Limits

Unlike an individual RRSP, the contributor to a spousal RRSP does not own the plan. Rather, the non-contributing spouse is the owner, or annuitant, of the spousal RRSP. This person makes the investment decisions regarding the assets in the plan, and is the only person permitted to make withdraws from the plan. The contributing spouse has no ownership or control over the assets in a spousal RRSP. In our example, although Jennifer makes the contributions to the plan, Jacob owns it, has control over it, makes investment decisions for funds held within it and ultimately makes withdrawals it.

Furthermore, note that in a spousal RRSP, it is the contributing spouse’s RRSP limit that governs how much can be contributed to the plan. In our example, when Jennifer contributes to Jacob’s spousal RRSP, the amount that can be contributed is determined by Jennifer’s RRSP contribution limit, and Jennifer’s limit is reduced accordingly when she contributes to the plan. Jacob’s RRSP limit is irrelevant and unaffected by Jennifer’s contributions to his spousal RRSP.

Review contributor strategy

If a contributor's and/or a plan owner's financial situation changes, if and how a spousal RRSP is used may need to be adjusted. Using the example above, if Jennifer's income was to decline, if Jacob was to begin earning more than Jennifer, or if Jacob was to assume a position with a pension plan, they should re-evaluate their spousal RRSP contribution strategy. Even if contributions are re-directed, the account would remain active, and funds within it would continue to grow tax-deferred, for Jacob to withdraw in retirement. However, new contributions may be better directed to Jennifer's own plan, or made by Jacob. While RRSPs and Spousal RRSPs are long-term investment vehicles, contribution strategies should evolve with  changes to household finances.

Beware the three-year attribution rule

There is one very important consideration to keep in mind regarding spousal RRSPs: a 3-year attribution rule. The rule states that, if any funds are withdrawn from the spousal RRSP within 3 years of contribution (the year of contribution plus the next two subsequent years) to a spousal RRSP, the withdrawal will be taxable to the contributing spouse.

For Jacob and Jennifer, a spousal RRSP makes sense for a couple of reasons:

Due to Jennifer’s current tax rate, the deduction is more valuable to Jennifer than to Jacob. That is, it makes more sense for Jennifer to contribute to a spousal RRSP for Jacob, rather than for Jacob to simply contribute to an individual RRSP for himself.

The subsequent withdrawals in retirement will be taxable in Jacob’s hands. This is desirable given that Jennifer already has a pension and significant retirement savings, RRSP withdrawals in her hands would be subject to a higher tax rate than Jacob because he has no other sources of retirement income.

If we assume that Jennifer contributes to Jacob’s spousal RRSP in the year 2022, that amount, if withdrawn in 2022, 2023, or 2024, would be taxable to Jennifer rather than Jacob. In this case, the intended function of the spousal RRSP is negated, and any income splitting opportunity is lost. To steer clear of the attribution rule and achieve the desired result of income splitting between spouses, it is therefore critical to avoid withdrawals in the years immediately following contribution to a spousal RRSP.

Next steps

If you’d like to learn more about how a spousal RRSP may accelerate your household retirement savings strategy, contact your Edward Jones advisor today.