A spousal RRSP may seem like one of the humbler tools in your financial planning toolbox, but it can still get the job done for clients interested in income-splitting.

The raison d’être for a spousal RRSP is to equalize income in retirement in situations in which one spouse or common-law partner is expected to have significantly more income than the other. So, leading up to retirement, the higher-income spouse uses his or her contribution room to make a deposit into a spousal RRSP for the lower-income spouse. The higher-income spouse gets the deduction today — and the lower-income spouse pays the presumably lower taxes on withdrawals in retirement.

Once money has been deposited into a spousal RRSP, it is owned and controlled by the spouse, not the contributor.

In situations in which one spouse has a pension and the other doesn’t, or there is an obvious discrepancy in the amount of income each will receive in retirement, spousal RRSPs have always been a simple and effective solution. But now that pension income-splitting rules have been introduced for retirees, do spousal RRSPs still serve a purpose?

“We’re still promoting them,” says Kevin Greenard, an advisor with the Greenard Group in Victoria, which operates under the ScotiaMcLeod Inc. umbrella. “The spousal RRSP was a perfect vehicle for people who planned early and received proper advice. Now, with the government stepping in and allowing pension income to be split, [that] basically helps all those people who didn’t plan properly.

“Some people might say we didn’t need to do these spousal RRSPs in the past,” he adds. “But I would disagree. People who did spousal RRSPs are now in a better situation, from a flexibility standpoint.”

Greenard offers a simple illustration of the continuing value of spousal RRSPs. If Spouse A contributes $10,000 each year to his plan alone, after 10 years (assuming no growth) he’ll have accumulated $100,000. He then converts his RRSP to a RRIF and, starting at age 65, withdraws $10,000 each year for 10 years. Under the new rules, he can split this income so he and Spouse B each receive $5,000 a year.

On the other hand, if Spouse A contributed $5,000 to his RRSP and $5,000 to a spousal RRSP each year, after 10 years (again, assuming no growth) each spouse will have accumulated $50,000. When this money is withdrawn at a rate of $5,000 from each account each year, Spouse B can report the full $5,000 in her income. Spouse A has the option of splitting his $5,000 with Spouse B or reporting the full $5,000 in his income, depending on his other sources of income.

So, even with pension income-splitting available, a spousal RRSP allows couples to fine-tune their income equalization in retirement.

Flexibility is something Michael Callahan, a financial advisor with Alterna Bank in Ottawa, likes about spousal RRSPs. He emphasizes that pension income-splitting applies only to certain types of income and there are age restrictions governing what can be split and when. Specifically, registered pension plan income can be split 50/50 at any age, but other qualifying sources of income, such as RRIFs, RRSP annuities, LIFs, LRIFs and DPSP annuities can be split only after the planholder reaches age 65.

A spousal RRSP can be used to even out income until pension income-splitting kicks in. Callahan says it’s an invaluable tool for those who retire early. Furthermore, as he points out: “If your client is one of the three-quarters of Canadians who don’t have pension plans, what is he or she going to do? The spousal RRSP is still an important tool in those cases.

“The other case in which it makes sense,” Callahan adds, “is when your client has reached the age limit [for contributing to an RRSP] but his or her spouse hasn’t.”

Your client can continue to make contributions to a spousal RRSP — provided that your client still has contribution room. “The spousal contributions are based on your client’s room,” he says, “and not his or her spouse’s.”

In this situation, the spouse who is 71 or older might need a tax deduction, and contributing to a spousal RRSP can provide it. Callahan cautions that money must not be withdrawn from the spousal RRSP during the year of the contribution or the two subsequent calendar years, or it will be attributed back to the contributing spouse. So, this strategy works best when there’s a significant age difference between spouses.

@page_break@Although the main purpose of spousal RRSPs is income equalization in retirement, they can be used to equalize income before retirement, too.

“The future is really unknown for a lot of people,” says Greenard. “And the greater the time horizon, the greater the uncertainty.”

He suggests that couples might experience an emergency down the road that requires them to access RRSP savings before they enter the lower-income retirement phase of their lives. For that reason, it makes sense to ensure both spouses have healthy RRSP accounts throughout their working lives. That way, if one spouse is still earning a significant income, he or she doesn’t have to withdraw from his or her RRSP. Instead, the lower-income spouse can withdraw the money and incur a lower tax liability.

“Without a spousal RRSP, you have movement only one way,” Greenard says. “If you do the spousal RRSP and equalize things throughout the couple’s lifetime, and an event occurs that’s somewhat unexpected later on, it provides the flexibility to go both ways.”

Spousal RRSPs can also help young couples maximize the amounts available to them under the Homebuyers’ Plan. The higher-income spouse can contribute to a spousal RRSP so that both spouses can withdraw the full $20,000 from their RRSPs to put toward the down payment on a house.

But repayments to the spousal RRSP must be made by the annuitant, not the contributing spouse, and amounts not repaid will be included in the annuitant’s income and taxed accordingly. The eligibility of RRSP deductions may be affected by Homebuyers’ Plan withdrawals made within 89 days of a contribution from both regular and spousal RRSPs.

Inheritances add one more layer of complexity to spousal RRSP planning. Greenard says that anticipated bequests should be carefully considered because the spouse receiving an inheritance may prefer to keep it isolated rather than commingling it with the couple’s other assets.

This approach can help to keep inherited assets out of equalization calculations if the couple divorces. But it may also lead to a significant discrepancy in income between two spouses — a discrepancy that can be addressed by having the anticipated beneficiary contribute in advance to a spousal RRSP. IE