Income Splitting

Income splitting is a tax planning strategy in which various techniques are used to minimize income taxes by establishing the same taxable income for each spouse or other members of a family unit.

Ownership of assets for tax purposed determines the tax burden on investment income during retirement. There are numerous opportunities to achieve income splitting between spouses during retirement, which can minimize your overall tax burden. Some of the more common income-splitting techniques include:

►    Federal pension income splitting

►    Contributing to a spousal RRSP

►    Accumulating equal amounts of non-registered savings

►    Splitting of Canada Pension Plan credits - "Pension Sharing"

►    Joint ownership of a residence of ownership by the "lower income" spouse

►    Saving and investing of the "lower income" spouse

►    Properly investing an inheritance

Here is a closer look at but one strategy:

Lower Future Taxes by Contributing to a Spousal RRSP

Many Canadian couples are not aware of the advantages of spousal RRSPs, and are missing out on one of the few income splitting techniques that can lower their future tax bills.

The Same Tax Deduction for You

Your annual RRSP contributions can be made to a spousal plan, your personal RRSP, or to a combination of both. Regardless of where you direct your contribution, the total of all your contributions must not exceed your annual contribution limit. When you contribute to a spousal plan, you receive the tax deduction, while your spouse has ownership of the plan and is entitled to control and keep the assets. Any contributions you make do not affect your spouse’s personal RRSP contribution limit. In retirement, your spouse will receive an income from the proceeds, paying tax on that income at a presumably lower tax rate.

Save Future Taxes Through Income Splitting

In using a spousal RRSP, you’re essentially shifting retirement income from one spouse to the other in an attempt to equalize retirement incomes and avoid having one spouse in the highest tax bracket. By spreading future taxable income between spouses, your overall tax bill may be reduced.

Let’s take a look at an example: A retired couple receiving $50,000 of retirement income from one spouse’s registered plan would pay approximately $10,060 in taxes, leaving the couple with an after-tax income of $39,940. If the RRSP money had been split between them through a spousal RRSP, $25,000 would be taxable to each spouse at a lower marginal tax rate. In this situation, the total family tax bill would be $4,200, leaving them with an extra $5,860 in their pocket or 14% more after-tax income per year.

Tax Deductions Beyond Age 71

You have until the end of the year in which you turn 71 to make your final RRSP contribution. However, if you continue to have earned income or have unused contribution room past this age, and if your spouse is younger than 71, you can continue making spousal RRSP contributions and receive the resulting tax deduction.

Maximize Your Government Benefits

By equalizing retirement incomes, you may help to reduce the Old Age Security (OAS) clawback and the age tax credit reduction.

And, at age 65, if your spouse does not have any other pension income, he/she could open a RRIF with funds in the spousal RRSP and, by receiving at least $2,000 each year from the RRIF, can access and claim the $2,000 federal pension income tax credit.

Tax Rules for Withdrawals

Spousal RRSPs can be a great tool for retirement planning, but there are specific rules governing them that pertain to withdrawals. Any withdrawals made by your spouse will be taxable in your hands if you made contributions to any plan in the year of withdrawal or the two previous years. Revenue Canada doesn’t distinguish between spousal contributions past their attribution deadlines and those that are still in the two-calendar year waiting period. You have to wait two full calendar years after the last contribution was made this rule exists to prevent investors from using spousal RRSPs as a short-term method of lowering their combined tax bill.

In certain circumstances, these attribution rules do not apply, such as death or living separate due to marital breakdown. In these instances any amounts from a spousal RRSP are taxable to the annuitant and not the contributing spouse. Also, once the plan has matured into a registered retirement income fund (RRIF), no attribution rules apply if only the annual minimum is withdrawn.

Spousal RRSPs have many advantages and can be a powerful long-term tax planning tool. Talk to your investment adviser about how you and your spouse can save future taxes with a spousal RRSP.

The information contained in this commentary is designed to provide you with general information only, and is not intended to be comprehensive advice applicable to the circumstances of any individual. We strongly urge you to seek professional assistance before acting upon information included herein.