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By Jonathan Chevreau
National Post
FP Weekend
Saturday, August 27, 2005 |
Spousal RRSPs have been an effective income-splitting tool since their creation in 1974. However, not even the Department of Finance knows how much money is invested in them.
Adrian Mastracci, investment counsel at Vancouver’s
‘fee-only’ KCM Wealth Management, says, "Taxpayers with earned income after age 69 can't add to their own RRSPs but can make spousal RRSP deposits until the year a younger spouse turns 69.”
Spousal RRSPs are likely underused by most couples, says Mike Hadford, financial advisor, "I've seen many employer sponsored group RRSP plans that do not allow for spousal contributions."
Financial planner Warren Baldwin says his clients are often surprised when informed of the income-splitting possibilities of spousal RRSPs.
They work best in a classic sole breadwinner situation, or where one spouse is in the top tax bracket and the second earns little or nothing.
Steve Salter, the Vancouver-based developer of RRIFmetic used his planning software to show that a family whose sole breadwinner makes $80,000 a year will enjoy an extra $1,100 a year in after-tax retirement income because of spousal RRSPs.
You don't have to be in a traditional heterosexual marriage to use this tax-saving vehicle. Common-law couples and gay or lesbian couples can also benefit from this strategy.
How does it work? We'll call the higher-earner Big Buck and the low-earner or non-earner Little Loon.
Say Big Buck is in the top tax bracket for Ontario, paying 46% in taxes on his last earned dollars. We'll assume he has $10,000 available in RRSP contribution room after the Pension Adjustment.
The couple open a spousal RRSP for Little Loon. Big Buck contributes the $10,000 and receives a normal $4,600 tax refund this year. The $10,000 is now legally the property of Little Loon and any investment earnings accumulate tax-free in her name over the coming years.
As with any RRSP, Little Loon names Big Buck beneficiary. In case of marital breakdown, the spousal RRSP is split like most other family assets. This is governed by provincial laws and rules may vary for non-traditional couples.
Come retirement, Big Buck draws a corporate pension while some non-registered investments are taxed mostly in Little Loon's hands. That's if Loon earned some money when working and invested it in her name, letting Buck pay the household expenses.
Little Loon (known as the annuitant of the spousal RRSP) makes regular withdrawals from what is now a spousal RRIF.
Big Buck's CPP benefits can be shared, with the split dependent on the length of the partnership and his years of CPP contributions. At 65, each receives Old Age Security benefits in their own names and are taxed accordingly. Ideally, income splitting keeps one or both members below the clawback threshold for OAS benefits. The net result should be the extra after-tax income estimated by Salter.
There are potential pitfalls. Every dollar Big Buck puts in the Spousal RRSP means one less dollar in his own RRSP. But he can apportion his available RRSP contribution room in any ratio he likes, says Baldwin.
Note there has been no new net amount of RRSP contribution room: What was already available is just used differently and more tax effectively.
Another consideration is a rule preventing spousal RRSPs from being used for short-term income averaging. When introduced, some couples made withdrawals mere days after the contribution.
Ottawa now requires a three-year period between making a spousal RRSP contribution and withdrawing it; otherwise it's taxable in the hands of the higher-income spouse. This may be waived in case of separation, death, emigration and other special situations. If you open a spousal RRSP at the end of December, you can cut this waiting time to just over two years.
Adrian Mastracci, president of Vancouver-based KCM Wealth Management Inc. says taxpayers with earned income after age 69 can't add to their own RRSPs but can make spousal RRSP deposits until the year a younger spouse turns 69.
Actuary Malcolm Hamilton says one-income families are heavily taxed compared to two-income families with the same income. Spousal RRSPs let them evenly divide their incomes and eliminate the post retirement tax disadvantage, says Hamilton, of Toronto-based Mercer Human Resource Consultants.
But the strategy is less useful if both spouses are working and in the top tax bracket.
As with other aspects of income-splitting, some groups can't benefit much from the strategy. "The group that gets lost in the shuffle consists of Defined Benefit pension plan members in one-income families," Hamilton says, "They can't use spousal RRSPs to any great extent because the DB pension plan consumes most of their RRSP room and the pension rules don't permit them to divide the pension between the spouses unless they divorce."
Relative to other Canadians, "this group is overtaxed both before and after retirement."
Dr. Moshe Milevsky, finance professor at York University's Schulich School of Business, says as long as there's a high probability you'll still be a couple when retired and a likelihood your spouse's income will be less than yours at retirement, "I can't see any good reason why NOT to use a spousal RRSP to equalize the RRSP flow."
Conversely, if those probabilities are low, it may be better to contribute instead to your own RRSP. Whether or not they have spousal RRSPs, lower-income spouses can do this as long as they also have some earned income of their own.
In The Pension Puzzle, Bruce Cohen and Brian Fitzgerald list some unusual situations where lower-income partners might make the spousal contributions. This might be advisable if the lower-earning spouse has a better pension, larger RRSP, expects a large inheritance or if the higher-income partner plans to leave the workforce in the foreseeable future.
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