Spousal RRSPs: An Overlooked Tax Saving Tool for Uneven Incomes.

When we think about spousal RRSPs (Registered Retirement Savings Plans), it’s easy to picture a tool solely for retirement savings, but Spousal RRSPs offer more than just a retirement planning advantage—they’re also a powerful way to reduce taxes and shift income. For salaried professionals, they present one of the few ways to split income and lower tax burdens effectively, especially if you and your partner are in different tax brackets. Let’s dive into why you might want to consider utilizing a Spousal RRSP as part of your financial strategy, both before and in retirement.

What is a Spousal RRSP, and How Does it Work?

A Spousal RRSP is a type of RRSP account that allows one spouse (the “contributing spouse”) to contribute to an RRSP in their partner’s (the “annuitant spouse”) name. The contributing spouse can deduct the amount from their taxable income, while the annuitant spouse will be taxed on the withdrawals in retirement or when funds are accessed later. The key here is that Spousal RRSPs shift income from one spouse to another, which is a tax-savings strategy when used by couples in different tax brackets.

If the contributing spouse is in a higher tax bracket, they receive a larger tax deduction when they contribute. Then, when the annuitant spouse eventually withdraws funds, those withdrawals are taxed at their (lower) tax rate, creating significant tax savings. While this is valuable in retirement, it’s also beneficial for couples who want to start income-shifting earlier.

Using Spousal RRSPs for Income Shifting Before Retirement

While Spousal RRSPs are primarily designed for retirement, they can also be an excellent tool for couples looking to shift income earlier, especially if the couple anticipates a change in the lower-income partner's tax bracket. Here are some scenarios where income-shifting through a Spousal RRSP might be useful before retirement:

Maternity or Paternity Leave: If one spouse plans to take an extended break for maternity or paternity leave, their income will drop significantly, meaning withdrawals from a Spousal RRSP could be taxed at a lower rate during that time.

Career Breaks or Shifts: Spouses considering a break from work, going back to school, or changing careers can use a Spousal RRSP to facilitate income-shifting, withdrawing funds when they’re in a lower tax bracket.

Early Retirement: In some cases, one spouse may retire early while the other continues working. Withdrawals from a Spousal RRSP can then be taxed at the retired spouse’s lower rate.

In each of these cases, the intent of the Spousal RRSP remains the same—income splitting for tax efficiency—but the flexibility of the Spousal RRSP allows couples to use it before retirement.

Example: How a Spousal RRSP Can Save Taxes

Consider a couple where one partner, Alex, earns $250,000 a year and is in a high tax bracket, while their partner, Jordan, earns $75,000 annually. Alex could contribute $10,000 to a Spousal RRSP in Jordan’s name, immediately benefiting from a tax deduction based on their higher marginal tax rate. Suppose Alex’s tax rate is 47%; they would save $4,700 in taxes through the contribution.

Now, if Jordan’s income remains at a lower level or even drops (for example, due to maternity or paternity leave), they can make withdrawals from the Spousal RRSP at a significantly lower tax rate. If their tax rate is 25%, they would only pay $2,500 in taxes on the $10,000 withdrawal, creating tax savings of $2,200. Through this strategy, Spousal RRSPs allow couples to reduce their tax liability while meeting income needs as they arise.

The 3-Year Attribution Rule

A critical detail to be aware of with Spousal RRSPs is the 3-year attribution rule. If the annuitant spouse withdraws funds from the Spousal RRSP within three calendar years of the last contribution by the contributing spouse, the withdrawn income will be attributed back to the contributing spouse for tax purposes. This rule is in place to prevent short-term income shifting and ensures that Spousal RRSPs are used for longer-term planning.

For example, if Alex contributes to Jordan’s Spousal RRSP in 2023, Jordan must wait until 2026 to make a withdrawal without the funds being attributed back to Alex for taxation. This rule is important for couples planning to use Spousal RRSPs for income-shifting before retirement, as it requires some foresight to time contributions and withdrawals effectively.

Addressing Common Concerns about Spousal RRSPs

Concern 1: Losing RRSP Contribution Room

A common misconception is that using a Spousal RRSP will reduce the Spousal RRSP account holders’ contribution room. However, this isn’t the case. Contributions made to a Spousal RRSP come out of the contributing spouse’s RRSP room but don’t impact the annuitant spouse’s room. The Spousal RRSP structure simply reallocates who will withdraw the funds in the future without impacting the overall contribution limit.

Concern 2: RRSPs Are Only for Retirement Savings

While RRSPs are primarily intended for retirement, Spousal RRSPs offer more flexibility and the opportunity to tap the key benefit of RRSPs at an earlier date. As highlighted above, Spousal RRSPs allow couples to benefit from income-shifting even before retirement, offering potential tax relief in scenarios where one spouse’s income is temporarily reduced. The key benefit of RRSPs is the withdraw of funds at a lower tax bracket than when you contributed, but what if your tax rate in retirement the same as when you were working? The main benefit of RRSPs disappears. Tax deferral is another great feature of RRSPs, but an often overlooked negative is that the investment gains will be taxed as regular income in retirement, not at the dividend or capital gains effective tax rate.

Why Spousal RRSPs Can Be More Than Just Retirement Savings

While traditional RRSPs focus on tax-deferred growth for retirement, Spousal RRSPs offer a unique advantage: they allow for income splitting in the years leading up to retirement. This flexibility means that couples can make use of RRSPs not only as a retirement tool but also as a strategic tax-shifting tool when one spouse anticipates a change in their income level.

The flexibility of Spousal RRSPs becomes especially valuable as life circumstances change. They provide a way to balance the tax burden and reduce it by leveraging the differences in tax brackets between partners. With proper planning, Spousal RRSPs can be a powerful component of your financial strategy, both for retirement savings and pre-retirement income shifting.

In Summary

Spousal RRSPs are a versatile tool, helping couples shift income, reduce taxes, and achieve greater tax efficiency. If you and your partner have differing income levels or anticipate changes in your income in the near future, a Spousal RRSP may be worth exploring. The 3-year attribution rule requires careful timing, but with some planning, a Spousal RRSP can provide significant tax savings before retirement as well as during retirement.

If you’re interested in how a Spousal RRSP might fit into your tax strategy or have questions on its flexibility, reach out to discuss the potential benefits. By using Spousal RRSPs strategically, you can make a meaningful impact on your tax liability and enjoy a more balanced financial future together.