Spousal RRSPs have been around for a long time, and are designed to lessen the tax burden of Canadians who are married or have a common-law partner, by balancing their income after retirement. But the rules governing spousal RRSPs can be complicated, and there are many factors to consider before deciding to open one. In this article, I’ll cover everything you need to know about spousal RRSPs, to help you decide whether or not it’s the right plan for you and your spouse.
How Does a Spousal RRSP Work?
In most situations, a spousal RRSP is opened in the name of the spouse who is expected to be the lower income earner in retirement. The RRSP plan is opened in their name, they control the account, and are responsible to make the investment decisions. The other spouse, usually the higher income earner, acts as a contributor to the plan, and any deposits made to the spousal RRSP are deducted from their income each year.
The idea here is that the contributing spouse will benefit more from the immediate RRSP tax deduction, due to the fact that they are in a higher tax bracket. But by making contributions into a plan owned by the lower income earning spouse, the long term benefit will be a more balanced income between spouses after retirement, because funds held in a spousal RRSP are taxed in the planholders name when they are withdrawn. This is considered a form of income splitting and can save couple’s thousands of dollars in taxes during their retirement years.
How Spousal RRSP Contributions Work
While the spousal RRSP belongs to the planholder (ideally the spouse with the lower income), the annual contribution limit is connected to the contributing spouse, who would normally be the higher income earner. For example, if the contributing spouse has an annual income of $80,000, they can contribute a maximum of $14,000 into RRSPs for that tax year. That represents 18% of their annual income. Now, if they deposited $4,000 to their own personal RRSP plan, then they would only have $10,000 left that can be contributed to a spousal RRSP. They will receive the immediate benefit of the income tax deduction. Withdrawals from a spousal RRSP are more complicated, and something I’ll cover in detail a bit later.
Who are Spousal RRSPs for?
The idea with Spousal RRSPs is to allow couples to balance out their income, thereby reducing the amount of tax they’ll pay after they retire. Spousal plans are ideal for situations where one spouse earns income in a much higher tax bracket, and as a result, will likely be in a higher marginal tax bracket after retirement as well. This is often the case for single income families, where one spouse stays at home to raise kids or has taken time out of the workplace for any number of reasons. It can also be the case when both spouses work full time if one has a higher income than the other.
Who Shouldn’t Contribute to a Spousal RRSP?
It’s important to note that spousal RRSPs are not for everyone. If a couple is in the same tax bracket, because their incomes are relatively equal, they may be better off with each person having their own personal RRSP plan. This is assuming that after retirement, both spouses will have relatively the same income. Also, if the balance of all RRSPs after retirement is expected to be small, then there may not be much point in opening a spousal RRSP. There are a number of other considerations to make before opening an RRSP. Let’s take a closer look at some of them.
Other Considerations to Make
As a general rule, the spouse with the higher income during their working years will also have the higher income after retirement. But this isn’t always the case. There may be other factors that impact the amount of money a couple has after retirement. For example, the lower income earning spouse may have a superior pension plan that will increase their post-retirement income. Many couples can expect to receive an inheritance at some point in the future? If so, it will affect how you draw income in retirement.
Do you plan to draw income from other, non-employment sources, such as from a rental property, or other non-RRSP investments like TFSAs? These are all things you’ll want to think about. Of course, you may not be able to answer all of these questions now, but by taking them into consideration, you’ll be better equipped to make the decision that’s right for you and your spouse.
Withdrawing From a Spousal RRSP
You need to be very careful when deciding to withdraw money from any RRSP plan, because of the tax penalties involved. But with a spousal RRSP, the impact can be even more severe, if you don’t follow the rules, specifically the spousal RRSP attribution rule. I’ll explain exactly how the attribution rule works in the paragraph below, but first, let’s look at the potential costs of making any RRSP withdrawal.
Withdrawing early from an RRSP can be costly. When you take money out of your RRSP, unless it’s for the purposes of the Home Buyers’ or Lifelong Learning Plan, you are going to pay withholding tax at the time of withdrawal. For withdrawals of $5000 or less, the government will withhold 10%. For withdrawals between $5,001 and $10,000, they withhold 20%, And for withdrawals over $10,000, they withhold a whopping 30% of the gross withdrawal amount.
It gets worse. You then must include the amount you withdrew as taxable income when you file your taxes for that tax year. So, depending on your tax bracket, you could pay substantially more income tax on the amount you pulled from your RRSP. While there are situations when withdrawing from an RRSP prior to retirement can be beneficial, it’s most often something that should be avoided at all costs. In fact, it can often be cheaper to borrow funds for an emergency, rather than pull from an RRSP, providing you can secure a decent interest rate. Another downside to withdrawing funds from an RRSP prematurely, is the lost growth potential, of having your investments removed from the markets.
Understanding the Spousal RRSP Attribution Rule
The main advantage of contributing to a spousal RRSP is the ability to lessen the tax burden on couples, especially when spouses are in different tax brackets. But if you don’t follow the rules closely, the strategy could come back and bite you. The spousal RRSP attribution rule can be found in the Income Tax Act, and states that contributions made in the year they are withdrawn, or the previous two calendar years, are taxed to the contributing spouse. Having this occur could negate any potential tax advantage, and result in a much higher tax bill for the contributing spouse. Here’s an illustration that will help you better understand how the spousal RRSP attribution rule works:
Linda and Alan have been married for 15 years. During this time, Linda has been the higher income earner. As such, she has contributed $14,000 to Alan’s spousal RRSP for several years, maximizing her RRSP contribution room each year. Her most recent contribution was made in January of 2019, which she deducted against her 2018 income.
A few months later, in April of 2019, Marie and Alan had an unexpected family emergency, which resulted in Alan withdrawing $45,000 from his spousal RRSP. Unfortunately, because Linda had made a contribution to Alan’s spousal plan within the current and previous two tax years, the withdrawal triggered the spousal RRSP attribution rule. As a result, $42,000 was taxed to Linda, based on her contributions of $14,000 in 2019, 2018, and 2017. The $3,000 remaining fell outside of the attribution period and was taxed to Alan.
This rule is the government’s way of making sure you can’t have your cake and eat it too. In other words, it prevents taxpayers from using spousal RRSPs to avoid paying taxes, without any intent to save the funds for their retirement. Attribution rules apply in other areas, but this is the one that you need to know in relation to spousal RRSPs
Other Advantages of Contributing to a Spousal RRSP
Opening a spousal RRSP can enable you and your spouse to double the down payment towards your first home. Under the federal government’s Home Buyers’ Plan (HBP), you can withdraw up to $25,000 from your personal RRSP, without having to pay withholding tax. But if you open a spousal RRSP as well, and contribute to both plans, you can effectively double the amount available for withdrawal, up to $50,000. This can be a great help, especially if you live in an expensive city, such as Toronto or Vancouver. You will need to replace the funds you withdraw under the HBP to avoid any penalties, but you have up to 15 years to do so.
The Lifelong Learning Plan (LLP) works the same way, except the funds can be used to help pay for you or your spouse’s post-secondary education. In this case, you could pull up to $20,000 from your own RRSP, as well as a spousal RRSP. Under the LLP, you have 10 years to repay the funds into your RRSP.
Ways to Invest a Spousal RRSP
In this day and age, with so many low cost investing platforms available, it’s important to make yourself aware of the many options you have to invest your spousal RRSP. Traditionally, many Canadians would turn to their primary financial institution, be it a bank or credit union, or an independent investment advisor. And while all of those are viable options, they are often a more costly and less convenient way to invest. For example, many banks will steer you towards actively managed mutual funds, to invest your spousal RRSP, while many independent advisors are compensated by charging you high fees on the funds you have invested with them.
Investing Your Spousal RRSP Through an Online Broker
Online brokers, also known as discount brokers, have become an immensely popular investment vehicle for thousands of Canadians. All of the major banks have their own discount brokerage, while some of the top names belong to independent brands, such as Questrade, or Virtual Brokers. With an online broker, you’re managing your own investments on the internet, rather than dealing face to face with an investment representative in a brick-and-mortar office. There are a number of advantages to this approach.
For starters, by cutting out the expensive middleman, you face far lower fees when you invest through an online brokerage. And you have access to an almost unlimited number of investment options. You can buy stocks, bonds, ETFs, if you want, you can still buy your standard mutual funds. The best part, you can do it all from the comfort of your living room.
As I mentioned, the online broker field is crowded, with a number of competitive players. But here at MapleMoney, our top pick has been Questrade, for some time now. Questrade offers the best combination of low fees, including commission-free ETFs, and ease of use. With Questrade, opening your spousal RRSP is a breeze, and can be completed online, which isn’t the case with everyone in the field. If you’re up for the challenge of making your own investment decisions, and the idea of low fees appeals to you, I highly recommend Questrade. In fact, you’ll earn $50 in free trades when you use my exclusive link to sign up!
Investing Your Spousal RRSP Through a Robo-Advisor
Another convenient, low-cost way to invest your spousal RRSP is through a robo-advisor. As with online brokerages, there are a number of companies offering robo-advisor services in Canada. Names like Nest Wealth or Wealthbar come to mind. Even the big banks are getting into the robo-advisor space. BMO Smartfolio is an example of this. If you are interested in the hands-off approach of a robo-advisor, our top choice is Wealthsimple. You may know the name from their quirky, yet attention-grabbing commercials. You can open a spousal RRSP via the Wealthsimple app, and get started investing right away.
Wealthsimple is the largest robo advisor in Canada, managing over $400 million in assets last time I checked. What I love about Wealthsimple is that they offer a broad selection of low-cost ETFs, with the ability to purchase fractional shares. You can invest your first $10,000 for free when you open a Wealthsimple spousal RRSP through MapleMoney, and after that, the annual fee is only .50% for balances between $0-$100,000. You’ll pay far more dealing with an independent investment advisor, or buying actively traded mutual funds through your bank.
Final Thoughts on Spousal RRSPs
A spousal RRSP can be the best plan for couples who expect to have very different incomes after retirement. The ability to balance out that income and pay less tax can’t be ignored. But there are many other factors you’ll want to consider before opening a spousal RRSP. For example, do you or your spouse expect to have other, non-RRSP income sources after retirement? Income from rental properties, other types of investments, an inheritance, or pension income, should all be considered. Also, it’s never a bad idea to consult with a tax professional before making your final decision. However you decide, you can be confident in your knowledge of how spousal RRSPs work.