For many otherwise financially astute families, spousal RRSPs are the tax-reduction strategy that got away.

Although they’re one of the few income-splitting vehicles left for couples, spousal RRSPs seem to be vastly underutilized.

“I would be very surprised if the utilization rate were more than 10%,” says Steve Bonnar, a principal with the human resources consulting firm Towers Perrin in Toronto.

“I’m sure they are not used in every circumstance in which they can be, so there is probably an opportunity to bring down the total family after-tax income,” says Adelle Leger, a national senior financial planning consultant for RBC Investments in Toronto.

Leger suggests that these plans make sense for couples — whether they are legally married or have been living common-law for at least one year — when a higher-earning spouse expects to receive a substantial company pension income upon retirement and a lower-earning spouse does not. In such cases, a spousal RRSP will help equalize a couple’s retirement earnings and minimize the total amount of income taxes paid.

Here’s how it works: a spousal RRSP is the same as a regular RRSP, except that it’s registered in the name of the spouse or common-law partner. The contributing spouse takes a full tax deduction for all the contributions he or she makes to the spousal plan, which helps equalize partners’ lifetime incomes.

Let’s say Spouse A has a higher income and is taxed at the 45% tax rate, and Spouse B has a lower income, taxed at the 20% rate. So if Spouse A contributes $1,000 to a spousal RRSP set up in the name of Spouse B, Spouse A immediately receives a 45% — or $450 — tax rebate. If Spouse B had contributed the $1,000 to separate RRSP account, the 20% tax refund would have been just $200, so the family is now $250 ahead.

At retirement, if Spouse A receives a company pension plan and faces a 30% income tax rate while Spouse B is at the 15% tax rate, having the same $1,000 withdrawn as income in Spouse B’s hands rather than Spouse A’s saves a further $150 in taxes, for a total lifetime family tax savings of $400.

Multiply the dollar amounts for the maximum contribution limits over a couple’s saving years, and the benefits could really add up, says Leger. The ultimate tax savings would, of course, be even greater, considering that within the RRSP, the initial contribution will probably grow through tax-deferred investment returns over the years.

But in order to see those great tax savings, couples need to invest in these plans earlier in their lives, Bonnar says. “For the spousal RRSP concept to do its job, the money needs to be in the RRSP a long while,” he says. “If someone contributes a fixed amount — call it $1,000 a year to their RRSP between ages 20 and 30 and nothing more after that —
they’d have roughly the same amount at age 65 as if they’d contributed $1,000 from age 30 all the way up to 65. That points out the value of early planning.”

And while some may be reluctant to contribute to a spousal RRSP in case of marital breakdown, Leger and Bonnar point out it makes no difference in dividing the assets when a couple gets a divorce.

“Under family law, you look at all the assets accumulated from the date of marriage and the spouses’ [assets] are equalized accordingly,” says Leger. “So I think that might be a deterrent to some people, but it’s not necessarily a valid one.”

Common-law couples who separate, however, should be aware that assets are not equalized in the same way, with the rules varying from province to province. Common-law spouses are advised to consult a family lawyer on the issue.

Contributions must be held in a spousal RRSP for at least three calendar years or the Canada Revenue Agency will tax withdrawals as income in the hands of the contributing spouse. A spousal RRSP account can be merged with a holder’s pre-existing personal RRSP account at this point. All funds in an individual’s regular RRSP account would then get the same tax treatment.

Advisors can add value, says Leger: “Within a financial plan, a spousal RRSP is a very good, very easy strategy to help split income for retirement years. It’s a very powerful tool, but a very simple tool to implement.” IE