Reduce taxes with a spousal RRSP

EPISODE SUMMARY

Here are a few ideas to help you contribute money to a spousal RRSP in a high tax bracket and withdraw in a low bracket in the future. In the right situation, you can drastically reduce your lifetime tax bill by using a spousal RRSP correctly.

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TOPICS IN THIS EPISODE

1. What a spousal RRSP is 
2. Why you might want to use a spousal RRSP 
3. Examples of a spousal RRSP in action 
4. Tax savings and other considerations 

RESOURCES MENTIONED

Government of Canada - Spousal RRSPs


OTHER EPISODES

13. Is an RRSP the Best Choice for your Retirement Savings

29. RRSP, LIRA, TFSA…Where do you Withdraw From First? 

38. The Perfect RRSP Strategy


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Transcript

Hello and welcome back to the Canadian Money Roadmap podcast. I'm your host, Evan Neufeld. Today is part six of my summer series, lots of S's here. The summer series I am focusing on ways for you to invest smarter and reduce your taxes.

Now today is going to be another one of those hybrid type of episodes. We're going to focus on something that is both a way to invest smarter and reduce taxes, but it's going to be talking about a plan type that I haven't spent any time talking about yet. And that is a spousal RRSP, not just a regular RRSP, but a spousal RRSP.

So when I say spousal, that is available to someone who's obviously married, but also common law spouses would qualify here as well. The way that this works is a little bit different. So let me backtrack and explain how an RRSP works. An RRSP allows you to contribute to the plan if you are working or you have earned income. In a spousal RRSP situation, the way that it works is that you can contribute to a plan on behalf of your spouse even if they're not working. So it's based on your income, but the money is then invested in the spouse's name instead of your own. So you would still get the tax benefit based on your income and your tax bracket, but the money would be invested in their name and it would accumulate in their name and hopefully be withdrawn in their name as well.

Now, why would you want to do this? Well, there's a couple of reasons, but the main one comes from the fact that if one spouse is making a lot more money than the other spouse, and maybe I should preface that a little bit better. If someone is in a much higher tax bracket than the other spouse, because you can make significantly more money than the other person but still be in the same tax bracket.  But the benefit here is if you are in a much higher tax bracket than your spouse today, it can probably be assumed that you're going to be in a much higher tax bracket in retirement as well. Now that might not always be the case, but let's use a ridiculous example here.

Say somebody is making $250,000 a year and here in Saskatchewan, that would put you in the top tax bracket.  I'll just use round numbers here and say that about 50% of your money goes to taxes. And at that level of income, any RRSP contribution you would make would get you a benefit of about 50% because you'd be in both the 50% tax bracket. It's closer to 47 and a half here in Saskatchewan but anyways, let's just use round numbers there.

So say this person is earning $250,000 and their spouse is a stay-at-home spouse, taking care of the kids and things like that. They don't have any earned income, so their tax rate is zero.  The stay-at-home spouse isn’t accumulating RRSP room because they don't have earned income. So if we can kind of project that situation into the future, the person who has earned more income has more RRSP room and hopefully is taking advantage of some of it. All the money that's being invested potentially, outside of a TFSA.  But all the money in RRSPs would be invested in the higher earning spouse's name. So that means in retirement, any income that comes out of that plan is then taxable in their name as well. And it can create a much higher rate of income then if things were split evenly.

Now things have changed a little bit in recent years where you can split income that comes out of a RRIF and a RRIF is just an RRSP, turned into an income vehicle. I call an RRSP like a bucket and a RRIF is like a bucket with a hole in it. So you have to take some money out, but that's another episode for another time.

CRA does let you split some of that income, but it's still not a perfect situation.  I won't go too far down that road here, but essentially in a situation like that, where all the taxable income might be invested in one person's name, the average rate on any money that you take out of that plan might be higher than you actually need to spend.

So when a case like this, you might want to use a spousal RSP. So again, in my hypothetical example here, what you would do is the higher earning spouse would then invest money in the spouse's name in a spousal RRSP who doesn't have any income. So then let's project that situation forward here a little bit. Then in the future, both spouses would have a pot of RRSP money that can be withdrawn from and the average tax rate for the whole household income would then be a lot lower because assuming that the whole household needs the same amount of income, regardless of whose name it's in, having some in both spouses names would be a great way to actually reduce your average tax rate.  Because again, the more money you make or the more taxable income you have, the more tax you pay. So the less income each person has, the lower the rate of tax that you pay on each. So using a spousal RRSP is a great way to split up money today so that you can have a split income in the future. So that's a situation where it can work. I would just refer to that situation as income splitting. 

Tax arbitrage is a term that I don't know if other people really use, but this is how I kind of think of it, where essentially, we can have that same situation, but not necessarily through their income earning years. So let's say that there is a spouse that's making money in that high tax bracket. Let's use that round number of 250,000, however, there is a plan for that other spouse to retire early.  Either they want to, they must because of health, they may be an industry with forced retirement and then the higher earning spouse, they might own their own business and they might want to work much longer. So the way that a spousal RRSP can work really well in that case if there's a situation where one spouse wants to retire at say 55, but the other ones to continue working into their seventies, but they can still live off that person's income. Essentially, what you can do is contribute to a spousal RRSP. Then once the retired spouse who has the spousal RRSP in their name, once they retire they can start taking money out.  And because everybody has a personal exemption amount (every province is slightly different), but let's call it $12,000. You can have about $12,000 of tax-free income every year.  A really neat strategy that you can do there is that retired spouse, even though they don't need the money to live on, they can start redeeming money out of their spousal RRSP, and they would get about 12,000 of it Tax-free. Uh oh, there's that word, Tax-free. And what you can do is take that money that's tax-free and put it into your tax-free savings account. So you can convert taxable spousal RRSP money into a potentially tax-free withdrawal that can then be invested in your TFSA and remain tax-free forever. Wow It's a bit of a mouth full there. You might have to go back and rewind that, or you can send me an email if you have any questions that I didn't really explain it very well. My contact info is in the show notes as usual.

But the situation there would be, well, the higher earning spouse is paying about 50% tax on any new money they make. So they get a benefit of about 50% when they put the money into the plan. If they would put it in their own name, there's a reasonable assumption that they would have to pay about 30%, at least in retirement to get that money.

But if they do it this way, it put it in the spouse's name and the spouse doesn't have any other sources of income for a number of years, they'd be able to take money out at their rate. Now you might be thinking, why don’t I just do this tomorrow. I have a stay-at-home spouse or common law partner and they're not working, or we have a big discrepancy in tax brackets. Why don't I do this tomorrow? Well, CRA knows that how this works and they know how it works well for people, which means it works poorly for CRA.

So what they've done is they've implemented it three year rule, which means that you can not withdraw money in the spouses name until there's been three years that have passed since the last contribution. So just like any good tax planning technique, it takes some planning in advance to make sure that it's done correctly.

So again, I would just want to do a quick summary here. So a spousal RRSP is a little bit different than a regular RRSP. You have to have one spouse that is earning some money, but the investment that is made in the other spouse's name and it accumulates in their name and is withdrawn in their name, assuming you've planned for it long enough in advance.

The benefit there is that assuming that the income is earned at a higher rate, it can be withdrawn at a lower rate in the spouse's name and that's always the idea with an RRSP. But it's not always as easy to do if you have things like a defined benefit pension, or if you're much higher earning spouse and your other spouse doesn't have any income.

So to be able to do effective income splitting using a spousal RRSP can be great. If you have a spouse that might be retiring earlier than the other, you could use a spousal RRSP strategies so that you can turn taxable income into tax-free income. You can't scale that up too high, but there is a way that you can do that and that's not illegal. It's not some loophole or anything like that. It's just taking taxable dollars and taking advantage of the personal exemption amount.

Anyways, this is probably one of the more complicated things that I've tried to explain on the podcast. I hope you stayed with me here, but again, like I mentioned before, if you do have any questions at all, feel free to send me an email. My contact info there is in the show notes, but the email is hello@evanneufeld.com.

Thanks again for listening and we'll see you again next time.

Thanks for joining me today on the Canadian Money Roadmap podcast. If you enjoyed today's episode, I'd really appreciate if you left me a review on apple podcasts with your biggest takeaway. If you have questions or ideas for topics you'd like me to discuss on future episodes, please reach out via my contact info in the show notes.

This podcast is intended to be educational in nature, and you should always consult your financial, tax and legal advisors before making changes to your financial plan. Any rates of return discussed are historical or hypothetical and are to be used for educational purposes only. Evan Neufeld is a Qualified Associate Financial Planner and Registered Investment Fund advisor. Mutual funds are provided through Sterling Mutuals Inc.