Thursday, August 17th, 2017
Do you recommend Spousal RSPs?
Not usually, no. If you're surprised at that, then you're like a couple I recently chatted with who had met with a financial advisor and were now convinced their top priority should be opening a Spousal RSP.
Because at a glance, they sound great, right? The higher income earner (contributor) gets a tax break now, and the lower income earner (annuitant) gets a tax break later. That's perfect – 2 tax breaks for the price of 1!
But there are some nuances to Spousal RSPs, as well as to tax law, that make Spousal RSPs far less attractive than they used to be.
Contributing to a Spousal RSP
It's true: with a Spousal RSP, the contributor gets to deduct the amount of the contribution from their taxable income for the applicable tax year. This is because the contribution comes out of their personal contribution room (not the annuitant's).
It's worth noting this is exactly the same tax break they would receive if they contributed into their own individual RSP.
So while the tax break for the contributing spouse is a solid benefit of Spousal RSPs, it's functionally no different had they have made a contribution into their own RSP.
Administering a Spousal RSP
I've found the actual administration of these accounts to be the most frustrating part for most investors, primarily because the contributor isn't the one who actually owns the account. And that means they don't make any decisions on how the Spousal RSP is invested. It's the annuitant who is responsible for the decision-making.
In my experience, this is tricky because it's often the contributor who wants to make the investment decisions on the Spousal RSP, since they kind of feel that it's "their" money. But the contributor's primary role as it relates to Spousal RSPs is simply to be a beneficiary of the tax deductions applicable for any of the contributions the annuitant makes.
Withdrawing from Spousal RSPs
There are some important but confusing rules regarding withdrawals that both the annuitant and the contributor should know.
Though the money in the Spousal RSP is the annuitant's, if the annuitant makes a withdrawal, that withdrawal will not always be attributed to their own income in the same way it is if you make a withdrawal from your own individual RSP.
In fact, if there's been a contribution into any Spousal RSP within the current calendar year or the two previous calendar years, then the amount of the withdrawal will be attributable to the contributor's income. This attribution rule is in place to avoid a loophole where contributors could get tax deductions for contributions only to have the annuitant immediately withdraw the funds without any corresponding tax consequences. The Canada Revenue Agency is smart.
So what is the actual benefit of a Spousal RSP, then? The answer: income splitting.
To minimize the amount of tax a household would pay in retirement, Spousal RSPs were created to allow for both partners to "own" RSP investments they can then withdraw from. The idea being that if a couple needs $50,000 for the year, it will be taxed less if both partners withdraw $25,000 rather than if only one person withdraws the full amount.
But in 2007, income splitting rules came into effect such that up to 50% of qualifying pension income (including withdrawals from an RSP or RIF) can be split with a spouse, provided you're over 65.
This change really makes the key benefit of a Spousal RSP redundant, unless you're planning on retiring well before age 65. If you are, then Spousal RSPs are still relevant.
This is why I don't generally recommend Spousal RSPs for couples. Most of us don't know when we'll be retiring, and because of the attribution rule which negates the tax benefit of a contribution if the funds are withdrawn shortly thereafter, you really need to plan out your withdrawals 3 years ahead or so. This means you can't make last-minute decisions to retire and start drawing down a Spousal RSP.
Spousal RSPs can be useful in reducing a couple's taxable income during retirement, since the withdrawals can be split between both partners' accounts instead of being withdrawn from just one.
This is most useful, though, for retirees under the age of 65, since pension income splitting is allowed on individual withdrawals after the age of 65.
So if you're planning on retiring before age 65, with one income significantly higher than the other, then a Spousal RSP makes sense. If you're not, it likely doesn't.
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This article is intended to provide general information only about Spousal RSPs. If you need further information about your specific circumstances, you should speak to an investment advisor.