Spousal RRSPs are an important tax-planning tool when establishing a financial plan. An RRSP is designated as spousal when one spouse contributes to a plan in the other spouse's name. It is possible for an individual plan to become a spousal RRSP if the spouse later contributes to the plan or if the plan accepts a transfer from another plan that was spousal.

Spousal RRSPs will appeal to couples where one spouse earns a higher income than the other spouse, and is therefore in a higher tax rate bracket. By contributing to a spousal RRSP, the spouse earning a higher income will receive a tax deduction at the higher tax rate.

For example, a higher income spouse in a 40 per cent marginal tax bracket contributes $5,000 to a spousal RRSP and would save $2,000 in taxes. If the lower income spouse, in a 20 per cent marginal tax bracket were to contribute $5,000 to an RRSP, this spouse would only save $1,000 in taxes.

At the same time, the couple is creating a pool of funds for the lower income spouse to draw on during retirement. When the couple retires, they both have funds which they can draw from as two separate incomes. By having two pools of funds to draw on, they will be taxed at a lower rates than if only the higher income spouse was withdrawing all of these funds as one individual income.

By establishing a spousal RRSP it allows couples to income-split, and takes advantage of Canada's progressive tax system. Of course, income-splitting only works if one spouse stays in tax rate brackets that is the same or lower than the other spouse.

Canada Revenue Agency (CRA) recognizes that income splitting creates tax advantages and has implemented an attribution rule to prevent the following type of abuse:

1. A higher income spouse, in a 40 per cent marginal tax bracket, contributes $5,000 to a spousal RRSP and saves $2,000 in taxes. If the spouse is unemployed and withdraws the money the next day they would not pay tax on this withdrawal. The couple has now saved $2,000 in taxes with no economic change. Attribution rules apply in this situation and the income would be attributed back to the contributor spouse.

2. Attribution also applies to funds withdrawn from any spousal RRSP where the spouse has contributed to the spousal RRSP in the same year or the two years prior to the withdrawal. Note that the amount attributed back to the contributor spouse will be the lesser of the amounts he/she contributed to all spousal RRSPs in the current or two prior years and the amount withdrawn by the annuitant.

As an example let’s say Mike contributes the following to his wife's spousal RRSP:
- 2006 $3,000, - 2007 $2,000, - 2008 $1,000, - 2009 $2,000

In 2009, his wife withdraws $8,000. Mike will have to include $5,000 (contributions made in 2007 to 2009) of the withdrawal in his income and his wife will include the remaining $3,000

Attribution can also apply to withdrawals from RRIFs if the contributor spouse made a deposit to the RRSP in the current year or previous two years. However, the attribution only applies to the excess amount withdrawn by the RRIF annuitant. The excess amount is any amount over the minimum withdrawals required by law. To avoid the income attribution rules, a spouse who is age 71 will generally not take any withdrawals in the first year of set up (all withdrawals in the first year are considered excess) and only the minimum in the next 2 years. After this time frame, any amount withdrawn will be taken into income by the spouse and no attribution will apply.

Attribution does not apply to annuities purchased with spousal plans.

Attribution will cease upon the death of the contributor or if the contributor or annuitant is non-resident at the time of withdrawal. It will also cease when spouses are living separate and apart from each other by reason of the breakdown of their marriage. However, if the spouses reunite, the attribution rules will apply again.

Remember that the age restriction for holding RRSPs (i.e. age 71) is only applicable to the annuitant, not the contributor. Therefore, a 75 year-old could contribute to his 65 year-old spouse's RRSP as long as he still has RRSP contribution room. The contributions must cease by December 31 of the year the spouse reaches age 71.

CRA allows the designation of "spousal" to be removed from a plan upon the death of a contributor. In the case of marriage breakdown some considerations must be met before the “spousal” designation can be removed: 

1. The annuitant and the contributor must be living apart at the time of the request

2. There must be no spousal contributions for the year of the request and the two previous years

3. There must be no withdrawals from the spousal RRSP in the year of the request

If you have any questions on this topic or would like a review of your current financial plan, please call 778-478-9759, or e-mail kzakus@northbayfinancial.com

This column is presented as a general source of information only and is not intended as a solicitation to buy or sell investments, or life insurance, and should not be taken as providing, investment, financial, legal, accounting or tax advice.