Relationships tend to run a little more smoothly when there’s an effort to make everything even or fair. After all, no one wants to get stuck with cleaning, cooking, child care and working while the other partner just sits at home all day.
When it comes to chores, it’s easy to ensure both partners are happy with their workload, but, when it comes to money, that balance can be much more difficult to maintain. Few partners make the same wage, and if one chooses to stay at home to look after kids, that pay gap gets really wide.
That can make retirement savings difficult to even out, which can cost couples more in taxes after retirement. That’s why it’s important to take advantage of every savings tool the government offers to optimize your retirement savings.
Spousal RRSPs are a great savings tool that allows couples to even out their retirement savings and save tax dollars when they need it most – in retirement.
Though slightly more complicated than a basic RRSP, spousal RRSPs offer a variety of benefits beyond evening out post-retirement income that make them worth the extra effort.
Benefits of Spousal RRSPs
As stated above, the largest benefit of a spousal RRSP is evening out retirement savings to lower the tax bill after retirement.
To help you better understand how that works, we’ll take a look at Bill and Joan, who are both currently working and saving for retirement.
Joan works for a large company and she brings in $100,000 a year. Bill, who works for himself, cut back his hours to take care of their children and makes $50,000 a year.
-> For the 2021 fiscal year, the max contribution limit was $27,830 or 18% of earned income from the previous tax year. That means Joan can invest $18,000 in her RRSP and Bill can invest $9,000.
Using those numbers on an ongoing basis, we can see that at retirement, Joan will have roughly twice as much in her RRSP as Bill. So, to make the numbers easy, we’ll say that Joan at age 65 has invested wisely and saved $1.5 million, which means Bill will have about half that, or $750,000. At a standard withdrawal rate of 4%, Joan will be taking out $60,000 a year, while Bill will take out $30,000 yearly.
For spending, that won’t make much of a difference as they can share the money once it’s taken out, but that split bumps Joan up into a higher tax bracket, while Bill still has plenty of room before he has to start paying a higher tax rate.
Because of that, it would be in their best interest for Joan to open a spousal RRSP so they can even out their post-retirement income.
So, instead of Joan putting everything into her own RRSP, she can put $13,500 in hers and $4,500 in Bill’s, while Bill puts his full amount ($9,000) in his own account.
This way, at retirement, they will both have $1.125 million and are pulling out an even $45,000 each – saving them from paying in that higher tax bracket.
The nuts and bolts of spousal RRSPs
While opening and maintaining a spousal RRSP is more difficult than opening your own, the basics are rather straightforward.
To keep things simple, let’s continue with the example illustration above.
In their case, Joan would simply open a spousal RRSP account in her husband’s name. She would act as the contributor, while he would act as the account holder. Essentially, that means she puts in the money, and he controls the account, including when to take out money and where the money should be invested.
After three years, Bill would be able to take money out of the account and all those deferred taxes would land on him. However, if the money is removed before three years is up, it would be added to the contributor’s (Joan) tax bill as income.
Other benefits of spousal RRSPs
There are more benefits to spousal RRSPs than just retirement, however. If a couple, like Joan and Bill, open an account early, Bill can withdraw some of that RRSP money while he’s at home looking after the kids and pay less tax.
Spousal RRSPs also have after-death benefits, which allows your estate to contribute money into a spousal RRSP in order to avoid paying additional income tax on your final tax return. They also allow those over 71, who are no longer allowed to contribute to their own RRSP, to switch their contributions to their under-71 spouse and still receive the tax benefits of an RRSP contribution.
Limits of spousal RRSPs
It’s important to remember that spousal RRSPs don’t add to your contribution limit for your RRSP. So, if your limit is $10,000, you can split it up any way you like, but if you contribute more than that, you will be penalized.
The largest drawback of spousal RRSPs come during a divorce or the break up of a relationship, where things can get messy. Depending on whether a couple is married or common-law, and where they live, different rules will apply.
For more information or to discuss your personal financial situation, please feel free to reach out to Bayview Financial Group.