When to use a spousal RRSP
Are spousal RRSPs dead? I don't think so.
And even though pensioners are now allowed to split income by reporting up to one half of their eligible pension income on their spouse's tax return, there are still lots of reasons to do some "old school" planning.
A spousal RRSP remains a useful income-splitting opportunity for couples, whether they're legally married, living common-law, or involved in a same-sex relationship - particularly if one spouse expects to have a lower income during child-rearing years or in retirement.
One reason is that there's no restriction on the percentage of income that may be split using a spousal RRSP, while the revamped pension rules restrict income splitting to 50 per cent of eligible pension income. Plus, a great many Canadians don't have access to the defined-benefit plans that create this type of pension income in the first place.
As well, while the rule changes of a few years ago may turn out to be a sizeable gift for certain pensioners, they're most useful to those 65 years of age and older. Keep in mind that the revised rules allow income from a corporate pension plan to be split before age 65, while RRIF or RRSP proceeds may be split only at age 65 and beyond.
People often get confused when it comes to figuring out how much they can contribute to a spousal RRSP. In fact, it's really quite simple: You can contribute any amount you wish either to your own RRSP or to your spousal RRSP, as long as the total contributed to both of them in a particular year doesn't exceed your RRSP contribution limit for that year.
Let's take Karen, who earned $55,000 last year. Her husband, Pavel, earned $37,000. Karen's RRSP limit for 2010 would be $9,900, which is the lower of 18 per cent of her earned income and the 2010 contribution limit ($22,000).
Karen may decide to contribute the entire $9,900 to her own RRSP, a spousal RRSP for Pavel or some combination of the two. Pavel's RRSP contribution limit of $6,660 is not affected in any way by any contributions Karen might make.
On the surface, most people tend to assume the higher-earning spouse should always contribute to a spousal plan on behalf of the other. While that's often true, it's not always that simple. What about the cases where the lower-earning spouse, say a teacher, can expect to receive that excellent guaranteed pension in retirement?
Or, what if the lower-income spouse has — or expects to have — other assets, such as an inheritance, that would actually translate into a relatively high tax bracket in retirement?
In these situations, the higher-earning spouse may actually be better off contributing to a personal RRSP. Remember, the real income-splitting advantage of spousal RRSPs lies not in a couple's differing tax brackets today, but rather where they're going to be upon retirement.
If you're closer to leaving work, there are also other advantages, particularly now that most provinces have eliminated mandatory retirement.
Let's say Pavel is older and plans to keep working in retirement. Even though he can no longer invest in an RRSP for himself, a spousal RRSP can be based on the age of the younger spouse or partner until the end of the year in which that person turns 71.
By writing the contract based on his younger spouse's age, Pavel can go on making contributions and getting tax relief until Karen reaches age 71, even if he's much older than that. And, the same would be true for Karen if she married someone younger for the second time or if she was actually older than Pavel.
Sadly, the death of a partner also offers a spousal RRSP planning opportunity.
After your death, no more contributions can be directed to your RRSP. However, if Pavel had unused RRSP contribution room upon his death and Karen was still young enough to contribute, she could make one final RRSP contribution on behalf of Pavel, but it would have to be a spousal RRSP in her own name.
The tax savings could be considerable and the actual cash might come from life insurance proceeds, for instance.
Just one more thing. Be sure to keep an eye on the three-year withdrawal rule: amounts withdrawn from spousal RRSPs are taxable back to the contributor if any contributions have been made to the plan in the year of withdrawal or in the two previous calendar years.