The biggest misconceptions people have when tax planning. This year I was able to experience my rawest RRSP season yet. Throngs of Canadians, most of you reading most likely, wait until the very last minute before realizing that they need to make an RRSP contribution, both to amp up their retirement savings for their golden years, however also to amp up their tax refund by using their contribution to lower their taxable income for their income tax return for the filed tax year. A Registered Retired Savings Vehicle, or RRSP, allows eligible Canadians with earners income to deduct 18% of their salary by contributing that amount, to a ceiling of 25000, allowing the contributor to reduce taxes owing by the amount contributed. The RRSP allows Canadians to hold cash, fixed income, or securities in which the growth remains tax sheltered as long as it remains in the plan. Once retired, the plan holder is able to convert this RRSP to a Retirement Income Fund, or RIF, and then withdrawals are taxed as income, when the plan holder is in most likelihood in a lower tax bracket. This year, about a third of Canadians choose to contribute to such a plan (this number has lowered since the introduction of the Tax-Free Savings Account), many of them in a frantic rush to hit the first 60 days contribution, which means the cut-off to use the contribution as a deduction against the previous year’s income. Having just taken on a role at Canada’s largest direct bank, where one can do self serve banking online or via telephone, I was able to see some of the more common errors people make in ‘RRSP season’. The most common I choose to mention here, is in regards to the spousal RRSP. A spousal RRSP acts in much the same way that a regular RRSP does. The same investments can be held, and contributions work as deductions as well. How they differ seems to be the confusing area. The reason to open up a spousal RRSP is for two spouses to have equal income in retirement. Whereas one can have a large income, and might not have any income, a spousal RRSP allows a couple to ‘split income’ thereby effectively putting each in a lower tax bracket, reducing total taxes owing. Because a Canadian needs earned income to be eligible for a RRSP, this allows a non-income earner to accumulate a retirement fund in the same manner that an earner might. The key difference is that the non-earning spouse that is opening up a spousal RRSP will have to name a contributor who will be funding the plan, and that contributor will get a contribution receipt for the deposit into their spouse’s plan. However, this account is more commonly opened by the earning spouse, listing their non-earning spouse as the contributor, and then are wondering why the contribution receipt for income tax purposes comes in the name as the non-earning spouse who does not have any income to deduct the contribution receipt. Phew. Try hearing that for 30 days straight. While the distinction does make sense to offer this to Canadians, so many people make such frequent errors when it comes to this account, that I can only pass on a few tips to clarify the guidelines when opening up the account.
TAX TIPS WITH REGARDS TO SPOUSAL RRSP’S
- Who is going to retire on this money? Open the account in this person’s name.
- Who has higher income? They should be the contributor for this type of account. They will receive the receipt for income tax purposes to deduct the contribution against their earned income.
- I contributed. Who’s money is it? After the earning spouse contributes, it is no longer their money. That money is now the non-income earning spouse’s. If withdrawn within three years of contributions, the contributor will face the tax consequences. Once the money has been in the account for three or more years, any withdrawals will be taxed at the accountholder’s expense.
WHEN TO OPEN UP A SPOUSAL RRSP
- Your spouse makes less money
- Your spouse make no money
- Your spouse does not have an RRSP, and yours is maxed out.
Ideally, in retirement, for income splitting and tax-planning purposes, you and your spouse will have equal balances in your individual RRSP and their spousal RRSP.