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Jim Maroney

:: Spousal RRSP contribution often messed up by investors and vendors

:: At this time of year, RRSP vendors like to champion the simplicity of “buying” their particular product. Knowing that we live in a time-strapped world, the idea here is to make the RRSP process as quick and effortless as possible. While the process part of RRSP investing can be, and has been, greatly simplified, the actual investment part still requires thought on the part of the investor. This is particularly true if you are considering whether or not to contribute to a spousal RRSP.

Before tackling this issue, we first need to take a step back for a moment to ensure we understand what a spousal RRSP is in the first place. Sure it’s simple but I never cease to be amazed how often investors and RRSP vendors mess this one up.

With a regular RRSP a taxpayer makes a contribution to a plan of which he or she is the beneficiary and claims a deduction on his or her tax return – in this case the contributor and beneficiary are the same individual. In contrast, a spousal RRSP is a plan whereby a taxpayer contributes to an RRSP in the name of a spouse yet claims the deduction for the contribution on his or her tax return – here the contributor and beneficiary are different individuals – in fact, they’re spouses.

To be perfectly clear, when referring to “spouse” in the context of income tax, provided certain criteria are met, there is no distinction between a spouse by marriage and a common-law spouse. Generally, common-law spouses are treated the same as married spouses where two people “cohabit in a conjugal relationship”, where a couple has had a child together or where the couple has cohabited for at least 12 continuous months.

Ignoring all of the technical mumbo-jumbo, a spousal RRSP is really government-sanctioned, long-term income splitting. The split in income doesn’t happen today but rather somewhere down the road, generally at retirement. Remember RRSP withdrawals are taxable to the beneficiary of the plan in the year the funds are withdrawn. With a regular RRSP the contributor and beneficiary are one and the same, therefore, there is no income split taking place. In the case of a spousal RRSP, the contributor is one taxpayer and the beneficiary is that taxpayer’s spouse, hence the splitting of income upon the withdrawal of funds.

Knowing that a spousal RRSP is a tool for splitting income at retirement, you need to consider the retirement funds that will be available to you and your spouse when that magical day arrives. In a perfectly planned retirement world both spouses would have the identical taxable income. In other words, both spouses would be in the same tax bracket paying income tax at the same marginal tax rate.

To properly plan such an outcome requires you to consider the estimated retirement income for you and your spouse from all sources including CPP, Old Age Security, investment income, Registered Pension Plan income and, of course, withdrawals from RRSPs (or RRIFs as they will then be known). The objective here is to achieve balanced revenue streams between the two spouses. This is where the spousal RRSP comes in handy since contributions to a spousal RRSP can be used as a form of equalizer between spouses. A spouse who expects to have a higher retirement income can make a spousal RRSP contribution to shift income into the hands of the spouse with the expected lower retirement income. Because financial and retirement circumstances change throughout our careers, fairly regular reviews of your particular situation should be the order of the day.

Notice that the income splitting benefit of a spousal RRSP contribution is long-term. Not being blind to the obvious, the rule-making mandarins in Ottawa anticipated that taxpayers would be making spousal RRSP contributions in one year followed by a withdrawal by the beneficiary spouse the subsequent year thereby achieving short-term income splitting. Nah, did they really think honest Canadian taxpayers would behave in such a manner? Judging from the attribution rules they put in place to prevent short-term income splitting, the answer is decidedly, yes.

To prevent the spousal RRSP from being used as a short-term income splitting tool, a rule exists that includes an RRSP withdrawal in the contributor’s income, rather than the income of the withdrawing spouse, if the contributor has contributed to any spousal RRSP in the year of withdrawal or in any of the two preceding years. Got that?

It sounds pretty complicated so an example will be helpful here. Brandon and Ashley live in a common-law relationship. Brandon contributes $1,000 to Ashley’s RRSP in February 2003 claiming a deduction on his 2002 personal tax return. A withdrawal by Ashley in any subsequent year up to and including 2005 will be taxable to Brandon. After 2005, provided Brandon hasn’t made any spousal RRSP contribution in the interim, a withdrawal by Ashley will be taxable to her and not Brandon.

In making a spousal RRSP contribution, understand that it is the available RRSP contribution room of the contributing spouse that determines how large a contribution can be made to a spousal plan and not the RRSP contribution room of the spouse who is the beneficiary of the plan. If you have no RRSP contribution room for 2002 and your spouse has $20,000 of room available, you cannot make a spousal RRSP contribution.

This being the case, it follows that contributions you make to a spousal RRSP have absolutely no impact on the ability of your spouse to contribute to his or her own plan – the two are completely independent of each other. What shouldn’t be independent, though, is how you and your spouse manage your combined RRSP contribution room if you want to maximize the benefits available with this income splitting tool.

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Free Tax Advice Article Submitted to Income Tax Canada.net exclusively by Jim Maroney
CA Canadian Chartered Accountant with Brown, Andrews & Maroney in Maple Ridge, BC, Canada

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