Income splitting: is it beneficial?

Since 2007, it has been possible for you to split up to 50% of your pension income with your spouse. This includes RRIF and LIF income, as of age 65.

In light of this, does it still make sense to contribute to a spousal RRSP?

Clearly, for common-law spouses, the risk of break-up is a significant barrier to making spousal RRSP contributions. With the new rules on income splitting, the relevance of such a strategy is open to question.

For married couples who have not waived the right to a division of family patrimony, however, transferring funds to a spouse is not problematic because in the event of divorce, the value of assets is divided equally between the spouses.

Aside from the issue of asset division for common-law spouses, there are still many good reasons to make spousal RRSP contributions, in particular:

• People with RRSP contribution room who cannot contribute to their own RRSP because they are over 71 may contribute to their spouse’s RRSP, if their spouse is 71 or younger.

• New contributions to spousal RRSPs allow for income to be split 100%, whereas income splitting rules limit splitting to 50%. In other words, when you contribute to your spouse’s RRSP, he or she will be taxed on the contribution amount at withdrawal. On the other hand, making the same contribution to your RRSP only allows you to split up to 50% at withdrawal.

• Since tax laws only allow RRIF splitting as of age 65, income cannot be split if you retire before then. However, with spousal RRSP contributions, income can be split before 65. As the average retirement age in Quebec is 59¹, spousal RRSP contributions can be used for this purpose during the transition period.

• Contributions to the RRSP of the younger spouse can extend tax deferral until he or she turns 72.

• Spousal RRSP contributions protect against any legislative changes that might restrict or even abolish income splitting for tax purposes.

• If a spouse is required or needs to make an early RRSP withdrawal and contributions have been made to a spousal RRSP, the tax payable can be lowered by making the withdrawal from the spousal RRSP.

• Spousal RRSP contributions can double the amounts that can be used for the Home Buyers’ Plan (HBP) if the spouse has not yet accumulated $25,000 in his or her RRSP. Funds could also become available for the Lifelong Learning Plan (LLP).

• Withdrawing amounts from the contributor’s balance sheet may provide protection against creditors.

Despite these many advantages, there are drawbacks to consider before deciding on a spousal RRSP. For example, when funds are contributed to a spouse’s RRSP, the contributor loses control of them. What’s more, the funds will be invested in keeping with the spouse’s investor profile, who can dispose of them as he or she sees fit, and creditors could go after the assets.

For many, these drawbacks are relatively minor compared with all the benefits derived from contributions to a spouse’s RRSP. Generally speaking, contributing to a spousal RRSP is a simple way to split income and reduce income taxes without the wealthier spouse being taxed on the withdrawals.

In conclusion, we believe that spousal RRSP contributions remain a key element in financial planning.

¹ RRQ Transition travail – retraite (in French only), Service des statistiques et des ménages, November 2005