Say I love you with a spousal RRSP

Flowers wilt and chocolates stale, but a spousal RRSP this Valentine’s Day can help put a little more gold in a couple’s golden years.

Sure, it’s not the most romantic gesture but becoming financial soul mates is crucial to any successful marriage, and failure to manage money together is its most common undoing.

The spousal RRSP is an often overlooked income splitting tool that allows married couples to balance the tax burden in their registered retirement savings plans, and lower the overall family tax bill in the long run.

A spousal RRSP permits a higher-income spouse to contribute to the RRSP of a lower-income spouse. The higher income spouse, who is in a higher tax bracket, can deduct the contribution amount from the top portion of his or her income. Like a regular RRSP the deadline to claim a deduction for 2012 is March 1.

Aside from the obvious benefit of having more money right away, the lower income spouse can invest and grow the contribution tax-free in his or her RRSP. When it comes time to retire and withdraw the money the contribution and returns will be taxed in the hands of the lower income spouse, in a lower tax bracket.

Better for richer than poorer ...

The name of the game in any retirement tax strategy is to keep as much of your hard earned dollars in your pocket and give as little as possible to the government. You do that by keeping most of your taxable income in the lowest tax brackets possible.

Over the years discrepancies often grow between the RRSP amounts of the higher income spouse and the lower income spouse. A spousal RRSP allows couples to balance their RRSPs and permit them to withdraw equal amounts.

Having that balance is especially important when plan holders turn 71 and must withdraw a minimum sum of money based on the total amount in the plan. If that amount is higher than $53,215, the higher income spouse will pay tax in a higher bracket and could face a claw-back in Old Age Security (OAS) benefits.

That could happen, for example, if a higher income spouse withdraws $70,000 and a lower income spouse withdraws $30,000. If they have equal amounts in their RRSPs each can withdraw $50,000 and avoid a higher tax bracket or OAS claw back.

Who is a spouse?

According to the Canada Revenue Agency a spouse is one of two people that have lived in a conjugal relationship for one year or more or live together and have a child.

The Income Tax Act has also been revised to provide the same tax treatment to same-sex common-law couples as opposite sex couples.

Every Rose Has a Thorn

As with most tax plans there’s a catch. Contributions made to a spousal RRSP are deducted from the allowable contribution limit of the plan holder, not the lower income spouse. That gives higher income spouses less contribution room in their own RRSPs.

The 2012 contribution limit for everyone is 18 per cent of income to a maximum of 22,970, but unused contributions can be accumulated and used in future years.

Also, contributions to spousal RRSPs cannot be withdrawn for at least three calendar years. The CRA has imposed a three year attribution rule to prevent a high income spouse from contributing to a spousal RRSP only for a quickie tax break.

If the funds are withdrawn within three calendar years they will be taxed in the hands of the higher income spouse.

There are circumstances and options that override the three year attribution rule so it’s best to talk to a tax specialist.