Spousal RRSPs - Understanding How They Work

RRSP time brings a number of questions including many on spousal RRSPs. This article will examine the use of spousal accounts and whether they are right for you.

What is a spousal account?

A spousal RRSP is an account in which you make contributions however, your spouse is the annuitant or the owner of the account. This means that your spouse has control over the account in terms of investment decisions and when payments are received from the account.

Why use a spousal account?

Effective tax and retirement planning would ensure that spouses had equal income at retirement to reduce the overall tax burden that a family would have. The main advantage of a spousal RRSP therefore is to help divide assets that will produce that future income. Usually, the higher income spouse contributes to a spousal RRSP and receives a tax deduction at a high marginal tax rate. Then in retirement, the other spouse withdraws that money to produce income and pays tax at a lower tax rate (subject to the attribution rules explained below).

As an example, a family with annual income of $70,000 earned by spouse would pay approximately $17,000 in taxes. However that same family with each spouse earning $35,000 would lower the tax bill to $11,900.

There may be situations where the lower income spouse would make contributions to a spousal account. In this case, they would likely be a member of a pension plan that is going to provide them with retirement income. Or, they have other assets that will cause them to have more retirement income than their higher income spouse.

Remember, the overall goal is to have both spouses with the same amount of retirement income.

How does a spousal account work?

When you choose to open a spousal account, your spouse’s name will appear on the account. You will be the contributing spouse and will receive the tax deduction, however, the legal owner of the plan is your spouse.

When they withdraw the money in the future, the taxes due will be in their name, subject to the attribution rules.

Attribution Rules

The attribution rules in the Income Tax Act are designed to prevent abuse of spousal accounts.

If a person makes a withdrawal from a spousal plan in the current calendar year and contributions have been made to any spousal account in the year of withdrawal, or the previous two years calendar years, that income will be attributed back to the contributing spouse.

The word “any” is important. A withdrawal from a spousal RRSP to which no contributions were made during the three-year period will still be attributed to the contributor’s income, if over that three-year period any contributions were made to any other spousal plans.

Note also the term “calendar year.” Making a spousal contribution in January 2004 would mean that the owner must wait until January 2007 before a withdrawal could be made.

However, if that same contribution was made in December 2003, and no other spousal contributions were made after, those funds could be withdrawn on January 2006, without any attribution.

Other Ways to Avoid Attribution of Income

In addition to the above, attribution of income from spousal withdrawals doesn’t apply in the following circumstances:

• If the funds in the spousal plan are transferred to a RRIF and only minimum withdrawals are taken. If more is taken, then the excess withdrawal is subject to attribution.
• If the spouse’s are living apart because the relationship has ended.
• If the contributing spouse died in the year a withdrawal is made.
• If either spouse becomes a non-resident.
• If the plan holder transfers money directly from the spousal plan to an annuity or to a locked in RRSP that can’t be cashed out for at least three years.

Can I make contributions to my spouse’s existing RRSP?

The short answer to that question is yes. However, as soon as you combine or co-mingle your spousal contributions with their regular contributions, the account is considered a spousal account for the purposes of the attribution rules as described above.

Depending upon your circumstances, it may be appropriate to have two accounts. If you were to require funds from an RRSP before retirement, and you had two accounts, you could withdraw from the account that made the most sense from a tax perspective (i.e., the account where the contributor would have the lower tax rate).

If the accounts have been co-mingled and are therefore a spousal account, the withdrawal would be taxed back to the contributing spouse.

Summary

Spousal accounts can be a very effective tool to help you plan for retirement. Talk to The Butler / Laing Group to determine if a spousal account is right for you.  Contact us at (604) 535-4749, or use our contact page.

The Role of Insurance in Tax Planning

Insurance has typically been used to protect against the risk of future financial loss. However, more and more, innovative insurance solutions are being used to safeguard the value of investors’ assets in a tax-efficient manner.

Creating a Tax-Free Wealth Transfer
Once you have a financial plan that ensures your capital will generate sufficient income and address your needs, you may want to consider shifting a portion of your assets to a tax-exempt environment. With a tax-exempt insurance policy, you can maximize the value of your estate and the value of your assets at death since the assets accumulate within a contract, free of annual accrual taxation. Part of the policy premium will pay for the cost of the insurance and the rest will be invested, allowing the policy’s ultimate benefit to grow through the years. Tax-exempt life insurance shares certain characteristics with other types of investments, however no other asset allows for all of the following:

• tax-deferred growth, much like within your registered pool of capital
• potential for tax-free income during retirement
• tax-free distribution on death

Protecting Assets Against Taxation
If you’ve worked hard to build your investment portfolio, it is worth protecting it from the eroding effects of taxation. This is especially critical for registered investments like RRSPs and RRIFs that become fully taxable on the death of a surviving spouse. Taxation concerns extend beyond your retirement assets to other investments or valuables such as the family cottage that may be subject to capital gains tax.

Generating Tax-Preferred Income

Creating an insured retirement strategy

An insured retirement strategy can help you meet the need for both supplemental retirement income and estate liquidity in a tax effective way. By allocating excess capital or income into a tax-exempt insurance structure a number of years ahead of retirement, you allow the investment component to grow over time into a large pool of capital, better known as the policy’s cash value. At retirement, up to 90% of this cash value can be pledged to a bank in exchange for a series of loans. As loans, the corresponding retirement income created is not considered taxable income. This approach is also a consideration for small corporations. Shareholders can use the tax-free loan proceeds against the cash value of a corporate-owned policy to supplement their retirement income.
Securing a guaranteed income stream
Life annuities can be very useful in providing a guaranteed, lifetime, tax-preferred income. An annuity is the opposite of life insurance: instead of paying an insurer small annual amounts in return for a large amount on death, you give the insurer a large amount up front and receive small annual amounts every year until death. Each payment is a blend of interest and a return of your original capital, of which only the interest portion is taxable.
If guaranteed income is a requirement as well as maintaining your estate, this can be accomplished by insuring your original annuity deposit. The net income from this strategy is often much higher than the net income from a GIC or bond, even with the cost of the insurance.
This strategy can be considered if you own shares in a small corporation.

The concept is the same: a higher net income for the shareholder than a traditional fixed income investment through the purchase of an annuity. However, an added benefit is derived from the corporation receiving the insurance proceeds at death, which allows for a greater amount of corporate wealth to be paid out of the corporation free of tax. Additionally, the corporation reduces the value of the shares, thereby reducing or potentially eliminating capital gains tax that might otherwise be owing on the value of the shares.

Minimizing Tax on Corporate Assets
A tax-exempt life insurance policy can be employed as a strategy to move surplus assets or retained earnings out of a corporation on a tax-preferred basis, significantly enhancing the value of corporate assets that are passed on to beneficiaries. This is well worth considering since annual growth on investment income inside a corporation is taxable at a higher rate than if owned personally. And when money is taken out of the corporation, it will be taxed again, most likely as a personal dividend, thereby creating double taxation.
The strategy involves shifting redundant corporate assets from a taxable portfolio to a tax-exempt life insurance policy. The proceeds of the combined death benefit and tax-deferred growth within the policy are paid to the corporation at death. This creates the ability to channel funds from the company to the shareholder’s estate without tax; an opportunity not readily available with taxable investments. The mechanism for this asset flow is an account that permits Canadian controlled private corporations to pay out tax-free capital dividends.
Minimizing Tax through Charitable Giving
The gift of life insurance can be effective in providing a practical and affordable way to make sizeable charitable gifts to your favorite charities or private foundation. Not only will life insurance help increase the size of your gift, in most cases it will provide significant tax benefits.

Contact us at (604) 535-4749, or use our contact page.