Most people think of Registered Retirement Savings Plans (RRSPs) as being for retirement. Duh, it’s in the name. However, for spousal RRSPs, the best uses are actually before you are old, wrinkly, and need the money to fund thirsty underwear purchases.
We previously did an overview of the basic anatomy of RRSPs, but in this post we will focus on the specific features of spousal RRSPs and strategies to use them to divert money from the government to fund your priorities rather than theirs.
Main Features of a Spousal RRSP
- Contributions are made by a higher income spouse to a lower income spouse’s spousal RRSP.
- The higher income spouse can deduct the contribution against their income, receiving a refund at their higher marginal tax rate. Beware of reduced refunds from moving down tax brackets.
- Investments in the RRSP grow tax-free (tax deferral).
- Withdrawals are taxed as income in the hands of your lower income spouse (tax reduction).
- Keep a spousal RRSP separate from that spouse’s personal RRSP to avoid difficulty with the attribution rules.
The attribution rules are where people can go awry with spousal RRSPs.
- If the lower income spouse withdraws the funds from their spousal RRSP when there has been any contribution in the previous two calendar years, then it is attributed back to higher income contributor and taxed at their higher marginal rate.
- I underlined “any contribution” because this is a common point of confusion. For example, if you put some stocks into a spousal RRSP 10 years ago and put some bonds in last year and this year your spouse removes the stocks, then their value would still be attributed back to you and taxed in your hands.
- The other point to remember is that it is by calendar year. If it is Nov/Dec and you are debating contributing now or waiting until Jan/Feb, then you may want to do it now to avoid needing to wait a whole extra year due to a two month delay. For example, you contribute $26K to a spousal RRSP in December 2017. In January of 2020, your spouse could withdraw the money as their own (a two year lag). If you had made the contribution in Jan of 2018 instead, they could not withdraw the money until January of 2021 without penalty (a three year lag).
The attribution rules limit our ability to use spousal RRSPs for short-term income splitting due to the 2-3 year lag, but they can be very useful for intermediate-term goals in four main ways:
- To fund a low income year, like a parental leave.
- Increasing the amount of money that you can access from your RRSPs for the Home Buyer’s Plan.
- Income splitting over a four year cycle.
- Evenly splitting retirement income if you retire before age 65.
Spousal RRSPs to Fund Parental Leaves
Professional couples have many advantages from an income standpoint, but one major disadvantage that they do face is that neither parent has maternity/paternity benefits. For physicians, many will start reproducing in residency which has the advantages of parental leave benefits coupled with the fertility prowess of youth. However, it also brings its own challenges combining the sleep deprivation of having small children with the demands of residency and licensing exams. For those who plan to start or expand their families after residency, a spousal RRSP can help as long as they start planning a couple of years in advance. Let’s look at a case to illustrate…
Sherry is a medical student and hooks up with Thor, a hunky Viking-type who has his own business as a massage therapist (total score!). Their relationship blossoms, and having read the Quest for the One Ring, they find themselves to be compatible and get married in the little hiatus between finishing med school and starting her surgical residency.
They plan on getting Sherry’s residency and exams out of the way and to establish her practice for a few years before having kids. She is concerned about de-skilling with time out of the OR and anticipates the many nights on call that come with the territory of being a surgeon. Thor’s work is more flexible. He plans to work a lighter load when they eventually pop a baby out, and will largely be the stay-at-home dad for a year or two until it is easier to get daycare.
Spoiler alert – daycare for infants is really expensive and hard to find for people who work unsociable hours. Being proactive and financially savvy, they plan for the parental leave using a spousal RRSP.
Between Thor’s massage skills and exhaustion from Sherry’s residency, they don’t get out to spend too much money. They max out their TFSAs (like everyone their age should) and Sherry contributes 43K to a spousal RRSP for Thor over her five year residency. She read this blog and doesn’t claim those deductions during residency because she knows she’ll be in a much higher marginal tax bracket as an attending.
Sherry graduates and makes $400K her first year as a surgeon. She uses her previously saved up RRSP deductions to get a 23K tax refund due to her 53.5% marginal tax rate. Thinking that they may want to have kids in a couple years, Sherry stops contributing to Thor’s spousal RRSP. She wants to avoid the attribution rules which require two full calendar years of no contributions before a withdrawal.
A year and a half later, the biological clock starts ringing. Thor brings on the thunder and nine months after that Sherry gives birth to their little demi-god. After two months, she heads back to work, relieved to be prescribing enemas again rather than dealing directly with the results. Changing diapers is not her thing.
Thor does the diapers and the occasional massage, bringing in $10K for the year. With their investment returns over the past 7 years, the spousal RRSP is worth $50K which he draws. His tax bill is ~11K for a net tax savings of ~$10K plus the $5K of growth from the RRSP. Sherry effectively shifted $50K from her 54% tax rate to her husbands 22% rate for a savings of $17K – that would buy a lot of diapers.
I used this example of a high earning physician with a lower earning self-employed spouse. However, it is applicable to numerous other situations. A lower earning spouse may be employed with parental leave via Employment Insurance (EI) that pays up to ~28K. If this applied to Thor in the above example, they would still save ~14K by using this income splitting technique.
A spousal RRSP could also be drawn on for tax savings in a year where your spouse has a low earning year due to job loss, illness, “finding themselves”, or some other unanticipated reason. The main problem is that you have to have stopped contributions two calendar years in advance, so it generally needs to be planned in advance.
Spousal RRSPs and the Home Buyer’s Plan
Owning a home is not a prerequisite for raising children. My parents rented the first few homes that I grew up in. However, it is often front and centre when the nesting instincts kick into high gear. A spousal RRSP can be accessed for up to $25K for the down payment on a first home. If the higher income spouse also has a personal RRSP, it can be accessed in addition, for a total of $50K.
Income Splitting Over a Four Year Cycle Using a Spousal RRSP
If one spouse is well into the highest marginal rate and the other makes no income, then you could use a spousal RRSP in a four year cycle. In the first year, the high income spouse (provided they have the contribution room) contributes three years worth of the max annual contribution. Then they don’t contribute for two calendar years to avoid attribution. In the third calendar year, the low income spouse can remove the money and it is taxed in their hands. Over those three years, the high income spouse has accumulated another three years of contribution room and contributes that amount in the following year to repeat the cycle.
Using the 2018 Ontario tax rates, that would save $22K in tax over the four year cycle for an average of $5575/year. It also has the advantage of giving the lower income spouse income that is attributed solely to them and therefore investable in a personal account with the investment income taxed in their hands.
I don’t personally know anyone who has used this strategy. It means more money in your hands in the near term and increases the option for intermediate income splitting with a taxable personal investment account, but it comes at the cost of burning up your RRSP room which you cannot get back. You will also note that when your spouse goes from no income to drawing on the RRSP, you lose the $2K spousal tax credit, and if the high income earner isn’t in as punitive a tax bracket as in this example, that can cancel out much of the benefit.
That RRSP room could possibly be better used to shelter your tax inefficient parts of your overall balanced portfolio (like bonds) and allow them to compound tax-free over the longer-term instead. That is what we do since we will likely be in a lower marginal tax rate when my wife and I access our RRSPs. My spouse also generates a decent income working for “The Man” (that’s me), so she is not in a super-low income bracket.
We also plan to retire well before age 65, so the spousal RRSP plays an important intermediate-term income splitting role for us. If you are thinking of using this sort of cycling strategy, you should probably consult a financial planning professional to see how it fits as part of your comprehensive plan.
Spousal RRSPs to Income Split in an Early Retirement
When you are over the age of 65, you can split up to 50% of your pension or RRSP with your spouse, and even with the proposed legislation, you should be able to give your spouse dividends from your CCPC if you have one. Income splitting becomes easy at that point.
However, if you plan on retiring or semi-retiring earlier than that, then spousal RRSPs may have a role to help evenly spread your retirement income between spouses to minimize the tax bite. To plan for this, you need to consider how much your retirement income will be and from what sources that will be drawn by each partner.
Some factors to consider:
- Does the lower income spouse have a pension from work that kicks in before age 65? Income drawn from a spousal RRSP at the same time as a work pension could bump them up tax brackets.
- Does the higher income spouse have a pension from work that kicks in before age 65? If the lower income spouse does not have a pension, then this is a good case to build a spousal RRSP with whatever contribution room is left after the pension adjustment.
- If you retire or semi-retire before age 65 and are going to have income from your CCPC or working part-time while your spouse has little or no income, then a spousal RRSP can be useful.
- Will you be drawing on your personal and spousal RRSPs for income prior to age 65? There are different approaches about when to draw on RRSPs depending on your overall plan and income. Some may “melt down” their RRSPs early to avoid Old Age Security clawbacks while others may defer drawing on their RRSPs until forced to at age 71. If you aren’t going to draw from your RRSPs before age 65, then a spousal RRSP doesn’t matter as much – as long as things work out as planned.
Are Spousal RRSPs Still Useful When You Get Really Old?… Depends.
For those trying to delay drawing from their RRSPs until as late in life as possible, then a spousal RRSP may be of use. If the higher income spouse is older than the lower income spouse, then a spousal RRSP does not need to converted to a Registered Retirement Income Fund (RRIF) until that younger spouse turns 71.
Is there a role for a spousal RRSP in your financial plan?
Spousal RRSPs have been around for a long time as a method of income splitting. Over that period, their utility has waxed and waned as the government changes the rules. When RRSP/pension splitting for those over 65 was introduced in 2007, many thought that this would end the utility of spousal RRSPs. Furthermore, with the option spousal dividends via CCPCs for many high income professionals, they have also been less popular. This may change with the new income sprinkling rules. As outlined in this post, there are a number of uses for the spousal RRSP to income split earlier in your life cycle.
At worst, I see the spousal RRSP as a “no lose” proposition if you are using RRSPs. At best, it gives you options in case things don’t unfold entirely as planned due to a children, health, an earlier retirement, or the government changing the rules to not allow RRSP/pension splitting (I can’t see that happening politically, but I have learned to never underestimate the ability of spin doctors). A spousal RRSP, as one plank in a multi-faceted financial plan, adds a layer of diversification against the risks of life and political risk.