Until death (and taxes) do us part Putting excess funds into a husband’s or wife’s retirement plan can reduce taxes for younger retirees, JEFF BUCKSTEIN writes
Adam Zileff has always liked to plan ahead. So two years ago, the 43-year-old graphics design entrepreneur set up a spousal registered retirement savings plan for his wife, Pauline, despite the fact the couple is still 15 to 20 years from retirement.
“I wanted to set it up early so I had lots of time to let the money build in the plan ..... I like to live for today, but I also want to be prepared for retirement and, right now, I’ve got time on my side,” says Mr. Zileff, who lives in Richmond Hill, Ont.
Contributing to a spousal RRSP has always been an excellent tax-planning strategy for families, and experts say it continues to be, even despite proposed changes to Canada’s tax laws that now make it easier for couples to split pension income after age 65.
“Spousal RRSPs are a very workable way of splitting income between spouses,” particularly if there is disparity between the higher and lower income earners, says Larry Hemeryck, a certified general accountant based in Simcoe, Ont.
By contributing to a spousal RRSP, the higher-income earner can even out income at retirement and thus reduce the family’s overall tax burden, he explains.
Beginning in 2007, seniors will be able to split their pension income, including RRSP proceeds, under proposed revisions to the Income Tax Act. But this new provision only kicks in at age 65. Because many Canadians are retiring and living off pension income before that age — as the Zileffs are contemplating doing — a spousal RRSP allows younger retirees to minimize their tax bite until they turn 65.
Taxpayers are allowed to contribute up to 18 per cent of their earned income from the previous calendar year toward an RRSP. But many Canadians do not realize this amount can be spread between their own RRSP and that of their spouse, says Cherith Cayford, a director with CMG Financial Education in Victoria.
They think they can do “either/or” rather than both, she explains, but so long as there is still contribution room, investors can put something into their own RRSP after contributing to a spousal plan. “That seems to be a big area of confusion when I’ve met with clients.”
Taxpayers also need to be aware that only the person who makes the contribution, whether to their own RRSP or to their spouse’s, is eligible to deduct that amount on their income tax return. “They get the deduction, not the spouse,” emphasizes Jack Lumsden, a senior financial adviser with Assante Financial Management Ltd. in Burlington, Ont.
Still, the family tax savings for retirees under the age of 65 can be quite substantial.
Dave Ablett, a senior tax and retirement planning specialist with Investors Group Financial Services Inc. in Winnipeg, illustrates how it can work by citing a hypothetical family income of $75,000 set against the Old Age Security threshold amount of $62,144 in 2006. The spouse with the higher income would have $13,500 of total RRSP contribution room (18 per cent of his previous year’s income) to spread between two RRSP accounts.
Mr. Ablett points out that if one spouse earned the full $75,000, then subtracted the $62,144 OAS threshold, the federal government would “claw back” $1,928 — 15 per cent of the $12,856 difference. But if the higher-income spouse invested that $12,856 in a spousal RRSP (out of the $13,500 total eligible RRSP space) the couple’s tax bill would be reduced such that neither spouse would be subject to the clawback and they would keep the $1,928 otherwise payable.
“That alone is a very significant factor which should encourage people to use income-splitting techniques such as spousal RRSPs,” says Mr. Ablett.
Spousal RRSPs can help evenly distribute income, and thus taxation, at retirement, when one spouse is participating in a registered pension plan through employment and the other is not, notes Mr. Hemeryck.
Another advantage of a spousal RRSP is that a spouse over the age of 69 who is still earning income but is no longer eligible to contribute to his or her own RRSP, can still make a contribution on behalf of a younger spouse.
That provision may become even more prevalent now that some jurisdictions, such as Ontario, have eliminated mandatory retirement, points out Mr. Ablett.
When contributing to a spousal RRSP, however, experts stress that investors need to be keenly aware of attribution rules which state that, under certain conditions, the amount withdrawn from a spousal RRSP will be deemed taxable in the hands of the contributor (who is presumably in a higher tax bracket), rather than the owner.
Attribution rules kick in when money is withdrawn from a spousal RRSP during the calendar year of the contribution, or in the following two years. The attribution rules follow a “last in, first out” technique, whereby the funds most recently contributed are considered to be taken out first.
Say, for example, a husband contributed $3,000 to his wife’s spousal RRSP on Jan. 15, 2007. If any withdrawals are made from that spousal RRSP in 2007, 2008 or 2009, the first $3,000 will be attributed to the husband, and become his tax liability.
Also, if the spousal contribution is made in the first 60 days of the new year and applied against the previous year’s income, the contribution is considered to have taken place in the new calendar year, Mr. Ablett noted. So if the husband makes a contribution on Jan. 15, 2007, for deduction against 2006 taxes, for attribution purposes it is considered to have been made in 2007.
These attribution rules do not apply, however, when the spouse converts her RRSP proceeds into a registered retirement income fund. The minimum annual amount that needs to be withdrawn from the RRIF is taxed in the hands of the plan-holder, regardless of when her husband contributed the funds to a pre-existing spousal RRSP.
Experts herald the spousal RRSP as an example of the type of planning investors should undertake decades before retirement.
“Sometimes people in their 40s and 50s aren’t necessarily thinking about where their money is going to come from in retirement, and what the tax consequences of it will then be,” says Patricia Lovett-Reid, senior vice-president of TD Waterhouse Inc. in Toronto.
“If they did, they’d have more money in their pocket.”