How to Pay Less Taxes with a Spousal RRSP

Forget “Will you marry me?” How about “I want to open a spousal RRSP with you.” That is what true love looks like. No marriage certificate necessary.

Nothing says commitment like combining your incomes and minimizing your overall tax bill. Keeping your financial house in order is a worthy endeavour that can pay off handsomely, whether in the form of affordable financing for a mortgage, a comfortable retirement, or that tiny tax bill. And this goal applies to couples just as much as it does to individuals. 

One tactic that couples can employ, both married and common-law, to enhance their financial standing is to open a spousal registered retirement savings plan (RRSP) account. If you’re familiar with RRSPs, you’re aware that they’re valuable tools for deferring your taxes. They also accelerate your investment growth, and earning you a hefty tax refund.

Well, a spousal RRSP functions in much the same way and offers the same benefits, except that it’s a retirement savings account that’s strictly for your spouse or partner. It’s an RRSP that you contribute to, but your spouse legally owns, or vice versa. Why do it?

Couples routinely use spousal RRSPs to bolster their savings and lessen their tax burden. It can reward them with more disposable income, especially during retirement. Read on to learn how opening a spousal RRSP could help you do the same.

What are the benefits of a spousal RRSP?

The primary advantage of a spousal RRSP is that it lowers your household’s total tax liability. It does this by allowing you to split your RRSP assets and income with your spouse. If you consider yourself somewhat of a tax specialist, you know that the greater the income earned by the lower-income spouse, the better due to Canada’s progressive tax system.

Therefore, transferring more income to the spouse in the lower tax bracket is generally a wise move. And this is what the spousal RRSP helps you to accomplish. It isn’t hard to do.

Let’s say you’re the sole contributor to an RRSP account held in your name and are the higher income earning spouse. If your total income places you in the highest tax bracket during retirement, a good chunk of your RRSP withdrawals could be gobbled up by taxes. By shifting a portion of your annual RRSP contributions to your spouse’s RRSP account, you can reduce your family’s total tax bill. The reason is that when they withdraw funds from the spousal RRSP, they’ll be subject to tax at a much lower rate than you.

Besides equalizing retirement income to minimize taxes, there are other situations where a spousal RRSP can be financially advantageous: a down payment for the purchase of a home. The Homebuyers’ Plan (HBP) allows individuals to withdraw up to $35,000 from their RRSP to finance a home purchase. 

If your spouse earns little to no income, you can open a spousal RRSP and contribute funds to it. Since your spouse is the legal owner of the account, they can also withdraw the maximum amount of $35,000, so together, you put $70,000 toward the down payment of your home. Like a regular RRSP, withdrawals made from a spousal RRSP under the HBP aren’t taxable. 

One spouse leaves their job for an extended period. Suppose that your spouse takes an extended leave of absence from work. The reason could be to be a stay-at-home parent or attend a post-secondary institution. You can ensure they have enough money to cover their expenses by actively contributing to a spousal RRSP. Because they’ll likely be in the lowest tax bracket, they can withdraw funds as needed while incurring a minimal tax bill.

On December 31, in the year in which you turn 71, you can no longer contribute to your personal RRSP. You must transfer the funds to an RRIF or withdraw them, even if you’re still actively earning an income and have unused RRSP contribution room. However, you can continue contributing funds to the spousal RRSP, provided that your spouse is under 72. By doing so, you can further add tax-sheltered savings to your family’s nest egg.

How does a spousal RRSP work?

Most financial institutions offer spousal RRSPs, which are easy and convenient to apply for and maintain. You can open an account if you and your spouse meet one of the following qualification criteria:

• You have lived together for a minimum of twelve months,
• You have a child together, or
• You share custody of a child from a previous relationship

Your financial institution will register one of you as the annuitant or owner of the spousal RRSP. The annuitant can choose what investments to hold in the account and reserves the right to withdraw or transfer the money at their discretion. The role of the other spouse is to contribute funds to the account. They can claim their annual contribution as a deduction on their tax return, as they would with their personal RRSP. This deduction is not available to the annuitant.

If they wish, the contributing spouse can carry forward unused contributions to deduct against future income. They must fill out and submit with their tax return, Schedule 7. This facilitates tracking of deferred contribution room.

The annuitant generally pays tax on all withdrawals they make from the spousal RRSP but with one exception, which we explain below. Like a regular RRSP, they can maintain the account until December 31 in the year they turn 71. At that point, they must withdraw the funds, transfer them to a registered retirement income fund (RRIF), or convert them to an annuity.

Important rules you need to know

Despite the benefits a spousal RRSP offers, there are some crucial rules you must be aware of to avoid any adverse tax consequences and penalties. It is not a free-for-all. Like anything related to taxes, there are rules to follow.

Contribution limits 

Your annual RRSP contribution limit remains the same, regardless of whether you deposit funds into your personal account or your spouse’s account. Therefore, contributing to a spousal RRSP will decrease your available limit. Your spouse’s contribution limit remains unaffected by any deposit you make. If you overcontribute by more than $2,000, you’ll be subject to a penalty of 1% per month on the excess amount for each month it remains in your account.

Withdrawals

When you contribute to a spousal RRSP, your spouse must not access the funds for at least three years from the date of deposit for you to avoid paying tax. If they make a withdrawal during this period, you’ll have to include it as part of your taxable income. This rule is called the three-year attribution rule.

Let’s assume you contributed $3,000 to your spouse’s RRSP in each of the years 2019, 2020, and 2021. In 2021, your spouse makes a withdrawal of $6,500. 

The amount you would have to report as income on your tax return is the lesser of 

• The total amount you contributed to the spousal RRSP in the current and prior two years 
• The total amount your spouse withdrew from the account 

In this case, you would have to include $6,500 as part of your taxable income on your 2021 tax return. Your spouse doesn’t have to report any amount as income resulting from the withdrawal.

One critical aspect to note is spousal RRSP contributions you make in January and February and report on your prior year’s return are still considered to have been made in the current year. In other words, the three-year period begins in the year you physically made the deposit, not the year you reported it. 

However, there is a situation where the annuitant has to claim the amount withdrawn. If your spouse withdraws funds from their account more than three years after making your last contribution, they must report the full amount as income on their tax return. You must keep good records to avoid any problems.

When a spousal RRSP is converted to a RRIF, it becomes a spousal RRIF. The rules surrounding RRIFs require the annuitant to withdraw a prescribed minimum amount each year. They’ll have to report as income on their tax return.

Suppose the withdrawal exceeds the minimum yearly amount. In that case, it will be attributed back to the contributing spouse if they’ve made contributions in the current year or prior two years.You can use the form T2205 to determine how much RRSP and RRIF income to include in your tax return and that of your spouse.

Transfers and rollovers

The Canada Revenue Agency (CRA) permits individuals to combine their personal RRSP and spousal RRSP, so long as both accounts belong to the annuitant. The annuitant can also transfer funds from their personal RRSP into the spousal RRSP. They can do this while retaining the account’s tax-sheltered benefit.

The contributing spouse can’t merge their RRSP with a spousal RRSP, nor can they transfer any funds they currently hold within their RRSP to their spouse’s account. Doing so will trigger tax consequences.When a regular RRSP and spousal RRSP merge, the new account is always deemed a spousal plan. The three-year attribution rule still applies when the two accounts are combined. 

Divorce and relationship breakdown

In general, during a divorce, a spousal RRSP is treated by courts as part of the family’s assets and split evenly between spouses. In the breakdown of a common-law union, resolving spousal RRSP ownership claims can be cumbersome and time-consuming. The outcome depends heavily on the province the spouses reside and its applicable laws. A formal joint agreement between the spouses might result in an unequal distribution of the assets.

If you’re married or in a common-law relationship, a spousal RRSP can be a valuable and flexible tool to lighten your household’s tax burden. The key is to utilize the account strategically by knowing when to make contributions and withdrawals. Understanding these rules is vital to avoid any nasty tax ramifications. 

A spousal RRSP works best when there is a sizable income disparity income between the spouses. If both spouses earn a similar income and contribute equally to individual RRSPs, a spousal RRSP’s benefits diminish substantially. In this case, other pension income splitting schemes may work better.

Be sure to consult with a professional financial planner if you need guidance on properly incorporating a spousal RRSP into your broader financial plan. Lead with your head and not your heart. You don’t want any nasty tax surprises.