Managing your finances as a couple can be challenging, especially when retirement and tax planning come into the picture. A spousal RRSP or spousal Registered Retirement Savings Plan, is an investment option to consider that can help both you and your partner save on taxes and retire sooner.
A spousal RRSP can help you achieve financial freedom and bring significant tax benefits to both parties. As the higher-earning spouse or partner reaps the benefits of available tax deductions, the lower-income spouse will have the opportunity to enhance their retirement plan.
Care to learn more about how to benefit from present-day income-splitting strategies and ensure yourself a financially stable retirement? You’ve come to the right place!
Key Takeaways
A spousal RRSP is a couple-oriented registered retirement savings plan..
You can open a spousal account at most financial institutions in Canada.
Both partners can hold both spousal and personal Registered Retirement Savings Plan (RRSP) accounts in Canada.
A spousal RRSP affects the contributor's annual contribution limit but not the partner's.
Special withdrawal rules apply to spousal RRSPs.
The account holder is the person who pays tax and who makes investment decisions related to the spousal RRSP.
A spousal RRSP in Canada is supported by the Canada Revenue Agency.
Spousal Registered Retirement Savings Plan: Basics
A spousal RRSP is a mutually beneficial way for married couples and common-law partners to build a worry-free and financially stable retirement future in Canada. The retirement savings plan consists of two parties: the contributor and the plan holder (annuitant). The contributor, usually the higher-income partner, opens an account in the name of their lower-earning spouse and contributes to the spouse's account.
Because the annuitant is in a lower tax bracket, withdrawals from the spousal RRSP — once it is converted to a Registered Retirement Income Fund (RRIF) — are typically taxed at a lower rate. However, if withdrawals are made within three years of a contribution, they may be taxed in the hands of the contributing spouse under the attribution rules.
How Do Spousal RRSPs Work?
A spousal retirement savings program is fairly simple to understand. Suppose that one spouse makes more money and falls into a higher tax bracket. They are allowed to help their spouse or common-law partner fund their savings account while reducing their own personal tax bill at the same time.
How do such mutual investment decisions work in practice? Let's imagine a family where one spouse – John – makes $80,000 a year. His wife, Sarah, makes around $40,000 annually. John decides to boost Sarah's retirement income and open an RRSP account for his life partner, contributing $5,000 in her name.
The contribution reduces his taxable income while her savings accumulate. When the couple decides to retire and withdraw the investment, Sarah, as the account holder, will pay lower taxes based on her lower income rate.
It is important to mention that spousal RRSP contributions are included as part of the investor's RRSP contribution limit. Your overall RRSP contribution room should not exceed 18% of your annual income. Moreover, it shouldn't exceed the $32,490 cap to avoid tax penalties.
Difference Between Spousal RRSP and Personal RRSP
Just like in the case of RSP vs. RRSP, spousal and personal savings plans share the same purpose but have a few differences. First things first – you can have both types of RRSPs.
For instance, a contributor can hold a personal and spousal account as long as their contribution room allows it. At the same time, the recipient can also have a personal RRSP. You can divide these accounts between different institutions or keep them all in one place.
A personal RRSP belongs to a single person who is responsible for all the operations, deductions, and withdrawals. A spousal RRSP allows a contributor to deposit funds and benefit from tax deductions, while withdrawals are typically the privilege of the annuitant.
Main Advantages of Having a Spousal RRSP Account
The Canadian income tax system can feel complex and confusing. At the same time, it offers a fair share of benefits to make use of. A spousal RRSP is clearly an advantageous opportunity to consider, and here's why:
Immediate earnings: Spousal RRSP investments grow tax-free, which allows for the accumulation of a more substantial financial reserve.
Palpable tax relief: Contributions to a spousal RRSP can reduce a contributor's taxable income significantly.
Special-program access: Spousal RRSPs can be used by the account holder to buy their first home or fund a spouse’s education. No withdrawal taxes will apply.
Retirement security: A spousal RRSP allows both partners to accumulate retirement funds independently, so that a couple builds a stronger financial foundation for their future.
Lower tax rate on withdrawals: Spousal RRSP or RRIF withdrawals are taxed at the rate of the annuitant's taxable income, which is usually lower than that of a higher-income spouse.
Extended eligibility: Contributions can be made even after the contributor reaches their 71st birthday, as long as the annuitant is under 71.
Potential Disadvantages of a Spousal RRSP
Along with the palpable perks of a spousal RRSP comes a set of drawbacks to consider:
Attribution rules: If the annuitant decides to withdraw money within the first three years from the date of deposit, the contributor will have to pay applicable taxes. Thus, the income-splitting benefit is annulled.
Contribution limits: The contributor’s personal contribution limit is divided between their personal RRSP and spousal RRSP accounts.
Breakups: When a relationship comes to an end, the question of splitting finances will arise, and depending on the situation, the contributor may be denied their right to the invested funds due to the power that the account holder has over a spousal RRSP.
Spousal RRSP Contribution Rules
The contribution rules are fairly straightforward when it comes to financing a spousal account. All you have to do is ensure that you don't exceed your own RRSP limit, which is 18% of your yearly income. For example, if your personal cap is $10,000 and you have already contributed $7,000 to your individual plan, the contribution to your spouse's account cannot be more than $3,000.
Spousal RRSP Withdrawal Rules
The main aim of a spousal RRSP is to establish a solid financial foundation for your spouse's or common-law partner's retirement. While it's designed for long-term savings, the funds can be accessed earlier under certain circumstances.
The Home Buyers’ Plan (HBP) and the Lifelong Learning Plan (LLP) allow you to withdraw from an RRSP (including a spousal RRSP) without immediate tax consequences, provided you meet the conditions and repay the funds on schedule.
For other types of withdrawals, a withholding tax applies, and early withdrawals can trigger attribution rules that shift the tax burden to the contributing spouse. Because of this, it's best to avoid using RRSP funds for short-term expenses like vacations or purchases, as it can undermine your retirement strategy.
If the owner of the account withdraws funds earlier than three calendar years after the initial contribution, the contributor may face increased taxes. For example, the direct contributions will be calculated according to their higher income tax rate, while the interest and dividends will be charged according to the account holder's tax rate. These implications will disappear after the three years have passed.
One more thing: since every rule has an exception, there are situations when the three-year rule does not apply to spousal RRSPs. They include the following:
If either the recipient or contributor dies.
If the relationship has come to an end.
If the partners aren't Canadian residents.
Conclusion
A spousal RRSP is a handy tool in a couple's financial arsenal. You can use it to build a brighter and more stable retirement while also reducing taxes. It’s always important to reach out to a reliable financial specialist who will explain any risks or spousal RRSP disadvantages to help you evaluate its potential.
Contact us today for a consultation. Our friendly professionals are here to help you prepare for your worry-free retirement.