More than a decade after the federal government first allowed the splitting of pension income, spousal RRSPs continue to make good sense for many of your clients.
“[Spousal RRSPs] are very simple and straightforward,” says Jamie Golombek, managing director of tax and estate planning with Canadian Imperial Bank of Commerce‘s wealth strategies group in Toronto. “All advisors should speak to their clients about the benefits of a spousal RRSP.”
These plans are intended for couples, both common-law and married, who have dissimilar income levels, notes Ed Rempel, a certified financial planner in Toronto.
“You’re using your own RRSP contributions, but you’re putting them in an account in your spouse’s name,” he says. “The goal is to have both tax brackets relatively equal.”
The contribution to the spousal RRSP, which comes out of the allowable RRSP allocation for the higher-income earner, works like any RRSP. The contribution provides income tax deferral in the year the contribution is made, and helps reduce taxes during retirement.
Income splitting, the foundation of a spousal RRSP, can lower a couple’s overall tax bill. Instead of the higher earner paying taxes in a high bracket, some income – up to 50% of the higher-income earner’s pension income – can be shifted to the lower-income spouse.
With a spousal RRSP, all of the eventual withdrawals are taxed in the hands of the lower-income spouse.
Income splitting also provides benefits when calculating old-age security (OAS) benefits and any potential clawbacks a client may face. Currently, OAS requires benefits to be clawed back once personal annual income exceeds $53,215. Contributing to a spousal RRSP can help a higher-earning spouse remain below that level.
“[Income splitting] is a useful planning tool,” says Rempel. “If you plan it right, you can pay fewer taxes after retirement.”
There are a few rules that require particular attention. First, there’s a time requirement. Says Golombek: “Be wary that spousal RRSPs are not meant for short-term income splitting. There is a three-year ‘look back’ rule.”
Under this rule, the taxes on withdrawals from a spousal plan will be taxed in the planholder’s hands only if no contribution has been made to the spousal RRSP for that person in the year of withdrawal or in the two preceding years. That requirement is intended to prevent a high-income earner from contributing to a spousal RRSP, then removing the money a short time later and having them taxed at the rate paid by the lower-earning spouse.
If a client violates the three-year rule, any amount withdrawn during that period will be taxed in the contributor’s hands. Determining when the three years begin can be confusing, according to Golombek. The key, he says, is to remember that the rule applies to calendar years.
The three-year time frame also can help you and your clients plan more effectively, Rempel adds: “Most advisors would be aware of this rule, but may not know how to use it because they don’t do detailed retirement plans.”
A detailed plan, he adds, would show whether your client should use a spousal RRSP, and how much to deposit into it.
A spousal RRSP also is a way to defer taxes for clients no longer able to contribute to an RRSP because of their age. As long as one spouse is 71 years of age or younger, the other spouse can contribute to that spouse’s RRSP and claim the tax deduction.
And in the event of the planholder’s death, transferring ownership of the account is simple: a copy of the death certificate and a letter requesting the RRSP be put in the spouse’s name is all that is required. “[The process] is not onerous,” Rempel says.
As well, even though no contributions can be made to a deceased individual’s RRSP after the date of death, contributions can be made to the lower-earning surviving spouse’s RRSP in the year of death or during the first 60 days after the end of that year.
There are a few potential downsides to spousal RRSPs that you should make your clients aware of. First, Rempel says, a spousal RRSP is an extra account that will have to be tracked separately. Second, he adds, RRSPs, including spousal plans, are not for everyone. The impact of later income from the spousal plan on matters such as tax rates and clawbacks on government benefits must be assessed before money is contributed to the spousal RRSP.
Contributors also need to understand that when they deposit money into a spouse’s RRSP, it’s no longer their money. “Once you’ve put it into a spousal RRSP, you can’t get it back,” Golombek says.
So, for couples unlucky in love, the spousal RRSP belongs to the lower-income earner. It’s also an asset of the marriage, and normally would be treated as property that ultimately is divided in the event of a divorce.
Talk to your clients about the potential benefits of a spousal RRSP, says Rempel: “Most clients don’t understand this at all. You need to educate them.”
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