January 2008

Contributing to your spouse’s RRSP: yes or no?

During RRSP season, we make decisions that will affect our lives in 20, 30 or 40 years. So, contributing to your spouse’s RRSP may be an excellent idea, even if the new pension income-splitting rules target the same goal.

The time has finally come for retirees to make the most of the new pension income-splitting rules announced in the fall of 2006. These rules take effect as of the 2007 fiscal year. So, as you prepare your income tax return, it’s time to use them.

Now, you might think that these rules make contributions to a spousal RRSP obsolete. In fact, such contributions let you split the pension income you and your spouse will have at retirement in advance, thereby lowering the income taxes you’ll have to pay. The new pension income-splitting rules let you do this after you and your spouse have retired.

Income-splitting: twice is better than just once

Why bother before when we can split after? For two main reasons:

  • because the two options are not mutually exclusive. You can use the spousal RRSP and, if needed, take advantage of pension income splitting later;
  • and, because two well-allocated RRSPs let you make better use of certain plans, especially the Home Buyers’ Plan.

How do you know?

Having an expert evaluate a couple’s situation is the only way to know if the spousal RRSP is actually relevant. However, you can get an idea by answering the following questions.

The spousal RRSP : questions and answers

Is there a difference between our two incomes or our individual savings? Like pension income-splitting, a spousal RRSP is effective if there is a substantial difference in income. If both spouses expect to have or already have equal retirement incomes, they have little interest in using any form of income splitting.
Is there a significant difference in our ages? You can continue to contribute to your spouse’s RRSP until he or she reaches the age of 72, even if you yourself are over the age where you can contribute.
Are we planning to use the HBP to purchase our home? If both RRSPs are well funded, the couple can use the HBP to finance a greater portion of their home.
Is either one of us planning to go back to school? Like the HBP, the Life-Long Learning Plan “pays” more if both RRSPs are fully used.
Do we plan to retire before age 65? You can’t use pension income-splitting before age 65. So, if you’re planning to retire early, a spousal RRSP is more flexible.

Other considerations

If you answered “yes” to any of these questions, here are other important items to consider:

  • Contributing to a spousal RRSP lets you split 100% of your RRSP contributions. The new pension income-splitting lets you split only 50% of your income. That’s a plus for the spousal RRSP.
  • There’s no guarantee that pension income-splitting will still be around when you retire. Also a plus for the spousal RRSP.
  • If you have to withdraw from your RRSP before you retire, contributing to your spouse’s RRSP might help reduce your tax burden. Yet another plus for the spousal RRSP.
  • A business owner who would like to set up an individual pension plan but has contributed heavily to his spouse’s RRSP may not be able to buy back all of his past service. A plus for income splitting.
  • Splitting your pension income once you’ve retired is a simple tax choice, but contributing to a spousal RRSP is an actual transfer of funds to your spouse. In the event of separation or divorce, such savings would, in all likelihood, be part of the estate to be shared between the ex-spouses. This might make income splitting more attractive.

One last point. The principle is the same for both options: distribute your and your spouse’s taxable income so that the income in the higher tax bracket is brought down to a lower bracket. But, it may be difficult to calculate the exact impact of tax rates, which is why it’s important to consult experts, starting with a financial representative and an accountant.