Are you one of the all-too-rare, but lucky, people with a solid pension waiting for you in retirement? For those of us who aren’t so lucky, it’s wise to start investing in RRSPs as soon as work-life begins. Also, it’s important to maximize that investment. And spousal RRSPs are one of the best ways to do that.
Married and common-law couples can benefit from contributions to a spousal RRSP. To clarify, this option allows you to distribute your contributions to the maximum possible tax benefit.
What Is An RRSP?
A Registered Retirement Savings Plan (RRSP) is a savings account that helps Canadians save money for retirement. Contributions to RRSPs are protected from income tax. In addition, there are a number of different types of investments. And as long as the funds are invested, earnings are also protected from tax. This helps grow your portfolio in time to retire comfortably.
What Is A Spousal RRSP?
Spousal RRSPs are a form of income splitting. They don’t make sense for everybody. But if you are in a partnership where one person earns significantly more than the other, a spousal RRSP is a good option. The idea is that the spouse with the higher income shifts some of that money to the lower-earning spouse. This helps lower his or her own tax bracket. To clarify, the contribution goes to the spouses’ RRSP instead of their own, lowering the spouses’ taxable income. However, the contribution is deducted from their own taxes.
When it’s time to retire, the lower earner withdraws the funds. And therefore, it is subject to less tax than if the higher earned withdraws the funds. This is a great option for couples where one person is likely to always be the higher earner.
Spousal RRSP Rules
You register the spousal RRSP in your spouse’s name. It is similar to a typical RRSP, however, there are specific rules to understand about this type of investment.
Every taxpayer has a yearly contribution limit. It depends on your income and previous RRSP contributions. This limit does not change if you contribute to a spousal RRSP. Instead, you divide your yearly contribution among your RRSP and your spouse’s. But, again, your overall limit does not change. So, say you have $25,000 in contribution room in 2020. You can contribute any or all of that to your spousal RRSP. However, anything above that $25,000 is subject to a penalty.
The spousal RRSP is in the name of the person with a lower income. And that person (the owner of the account) receives the tax benefits. Additionally, the owner of the RRSP pays any associated withdrawal fees. However, if the owner of the account withdraws the money within three years of his or her spouse contributing to it, then the spouse pays any related withdrawal fees.
A spousal RRSP is similar to a regular RRSP. For one thing, there are tax implications on pre-retirement withdrawals. However, after retirement, all RRSPs (spousal or otherwise) convert into a non-RRSP savings vehicle, such as a Registered Retirement Income Fund (RRIF).
You can withdraw funds from a spousal RRSP for things other than retirement. For example, the Home Buyer’s Plan (HBP) allows first-time homebuyers to withdraw from a spousal RRSP for the purchase of a first home. In addition, the Lifelong Learning Plan (LLP) allows the person to withdraw the funds to apply them towards tuition for post-secondary education. There is no tax penalty on these withdrawals. But you must pay back the money in full, within 15 years. And the payments are annual.
Who Can Make Contributions To A Spousal RRSP?
Contributions to a spousal RRSP apply in cases where couples are either legally married or legally common-law partners. The idea is that you, as a couple, receive the best possible tax benefit and savings vehicle to prepare you both to retire comfortably.
What about age limits? If you reach the age limit to contribute to your own RRSP (71), but your spouse is still under the age of 71, you can continue to contribute to their RRSP until they turn 71.
How To Open Spousal RRSP Account
There are a few steps to setting up a spousal RRSP. First, select the recipient. Typically, this is the person with the lower-income, and with more wiggle room to increase their income without a significant tax hit. It’s also important to select a beneficiary. Then, open the account as similar to any other type of savings tool. A financial professional can help guide you through the process.
Can You Transfer RRSP To Spousal RRSP?
Your RRSP is in your name. And you cannot transfer it to another person, not even a spouse. Transferring the funds is the same thing as a withdrawal and a new contribution. Therefore, doing so means a significant penalty to the original account holder.
Can A Spouse Who Claims a Spousal RRSP Convert It To A Regular RRSP?
Yes, as long as it remains in the name of the annuitant (name on the account) and not in the name of the spouse who contributes to it. When it comes to RRSPs, spousal or otherwise, accounts remain in the name of the holder. Any changes to the account holder are equal to removing the funds. And doing so means a tax hit. But if it remains in the name of the annuitant, you can transfer it to a different investment vehicle.
Who Can Withdraw From Spousal RRSP?
Once you set up the spousal RRSP, the account holder controls the account. To clarify, only the plan holder can withdraw funds from it. However, withdrawing funds within three years of a spouse contributing to it means the contributor pays a tax penalty, not the plan holder.
When Can I Withdraw Spousal RRSP?
For a spousal RRSP, there is a three-year waiting period when withdrawals are not advised. Before that time, withdrawals are subject to a penalty and fees. And the person who contributed the funds pays those fees. However, after that three-year period, attribution rules apply. So, the spouse whose name is on the plan is in charge of withdrawal-related expenses.
What Happens To A Spousal RRSP Upon Divorce?
Spousal RRSPs are no different from a regular RRSP or any other asset upon the dissolution of a marriage. Upon divorce, all RRSPs and RRIFs get divided equally and are transferred tax-free to ensure an equal division. This makes a spousal RRSP no different than a typical RRSP.
What Happens To Spousal RRSP After Death?
The federal Income Tax Act looks at the money in a deceased person’s RRSP as if it was paid out just before the death of the plan holder. To clarify, that means the funds are included in the total assets as income at the time of death. So when completing a tax return for the deceased, the income from the RRSP is added to the overall income and is taxed accordingly.
There are, of course, exceptions to that rule.
If you are the named beneficiary, you can avoid a tax hit by rolling that amount into your RRSPs.
Dependants Or Grandchild
If the money is earmarked for a child under the age of 18, the funds in the RRSP can be rolled into an annuity that pays the child in increments until they turn 18. You divide the tax hit over the number of years remaining until the child turns 18.
Spousal RRSPs in Canada
The spousal RRSP is a great choice for married or common-law partners looking to maximize their retirement savings. And while the rules are very similar to a typical RRSP, it’s important to understand the special considerations when opening a spousal RRSP. Talk to a financial professional to ensure you’re getting the most out of your spousal RRSP contributions.