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How spousal RRSPs help with tax savings in retirement

Canada offers several tools to help its citizens save tax. However, it’s up to you to understand them and take advantage of the ones that work best for you and your family. After all, it’s not how much you earn, but how much you keep that matters most. To that extent, proper tax planning means making the most of the tax-saving strategies available to you.

For those who qualify, a spousal RRSP is one of the most powerful tax-savings strategies.

The basics of spousal RRSPs

If you earn more income than your spouse or common-law partner does, you can make contributions to a spousal RRSP in their name, and they will make the withdrawals in retirement.

A spousal RRSP is essentially an income-splitting tool: the key outcome is shifting some retirement income to your lower-income spouse.

When we talk about higher- and lower-income spouses, it’s not so much the difference in your current incomes but the difference in your retirement incomes that matters most when determining whether a spousal RRSP will be advantageous for you.

Even without a spousal RRSP, couples can split up to 50% of eligible pension income. This can include withdrawals from a registered retirement income fund (RRIF) or income from a registered company pension plan.

But with a little advance planning, a spousal RRSP could let you move more than 50% of your pension income to your spouse, something that might be useful if you have other sources of income when you retire. (A spousal RRSP can also provide earlier income splitting opportunities.)

Let’s take a closer look at a scenario to illustrate how a spousal RRSP can help structure a tax-efficient retirement income.

Meet the family

Dr. Dara Balogun and her husband, Toby, have been married for about 10 years and live in Ontario. Dara is an unincorporated physician who earns approximately $350,000 and has a 53.53% marginal tax rate. (Your marginal tax rate is the rate of tax you pay on the next dollar of income you earn.)

Toby is a carpenter earning $60,000 and has a much lower marginal tax rate of 29.65%.

Neither Toby nor Dara has an employer pension plan. Toby’s notice of assessment indicates that his RRSP deduction limit is $10,000 this year, while Dara’s shows that her limit is $25,000. Their goal in retirement is to have a combined household income of $150,000 before tax.

Dara and Toby have a total of $35,000 available for RRSP contributions this year. What should they do?

1. The strategy

In this scenario, a spousal RRSP could be a powerful tool to help the Baloguns manage their taxes in retirement. First, let’s clarify some key terminology for spousal RRSPs:

  • Annuitant: This is the spouse who owns the spousal RRSP and eventually withdraws the money from the account. In most situations, the annuitant is the lower-income spouse. In our scenario, Toby would be the annuitant.
  • Contributor: This is the spouse who makes contributions to the spousal RRSP and receives the corresponding income tax deduction for those contributions. In our scenario, Dara would be the contributor.

It’s important to understand how RRSP contribution room is affected when using a spousal RRSP. In short, it is the contributor’s RRSP contribution room that is affected, not the annuitant’s, even though the annuitant owns the account.

In our scenario, when Dara contributes to Toby’s spousal RRSP, it is her RRSP contribution limit that is impacted, not Toby’s. So even if Dara contributes her full $25,000 to Toby’s spousal RRSP, Toby can still contribute $10,000 to his own RRSP.

2. Why it works

Dara could use all of her contribution room to make contributions to the spousal RRSP; or she could contribute some to her own RRSP and some to the spousal RRSP, in any combination. Both could be valid, depending on the scenario and other elements of the financial plan.

The point here is that at least some of her RRSP contribution room is now going toward building Toby’s retirement income. This allows Toby to accumulate RRSP savings much faster than would be possible with his own, individual contributions alone.

Furthermore, although the spousal RRSP contributions accrue to Toby, Dara still claims the deduction for her contribution, and thus achieves a meaningful reduction in her taxes today.

Recall that Toby and Dara’s goal is a retirement income of $150,000 a year before tax. Without a spousal RRSP, this would be mostly Dara’s income — let’s say $120,000; and $30,000 would be Toby’s, from his individual RRSP. The result would be a $35,875 tax bill and an after-tax income of $114,125.1

However, if they use a spousal RRSP to bump up Toby’s income so that each has an income of $75,000, their total tax bill would be only $30,410.

 

No spousal RRSP

With spousal RRSP

Income

$120,000 (Dara) + $30,000 (Toby) = $150,000

$75,000 + $75,000 = $150,000

Tax

-$35,875

-$30,410

After-tax income

$114,125

$119,590

In other words, although their total household retirement income would be the same at $150,000, the spousal RRSP strategy could help them save approximately $5,465 in taxes every year, simply by balancing their incomes.

Speak to an MD Advisor* to determine if a spousal RRSP would work for you and your spouse, given your financial planning and retirement goals.

* MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec), or an MD Private Investment Counsel Portfolio Manager.

1 These calculations do not include non-refundable tax credits other than the basic personal tax credit.

The above information should not be construed as offering specific financial, investment, foreign or domestic taxation, legal, accounting or similar professional advice, nor is it intended to replace the advice of independent tax, accounting or legal professionals.