Spousal RRSP Strategies

Strategically saving for future income splitting and tax splitting

Our tax rules allow you to put money in your own registered retirement savings plan (RRSP) or an RRSP of your spouse or common-law partner. We’ll use the term spouse to refer to spouse or common-law partner in this article.

- For your own RRSP, you are both the contributor and annuitant/owner.
- For a spousal RRSP, you are the contributor and your spouse is the annuitant/owner.

As contributor, you are entitled to claim a tax deduction, whether the funds go into your RRSP or your spouse’s. The annuitant is then taxed on later withdrawals from the plan – so long as you stay within the rules, as discussed below.

This can be a simple, effective tool to help couples get more spendable cash out of savings in retirement. It can also be used strategically to manage near-term cash flow and taxes, and to ease the transition in the years leading up to and into retirement.

Principal benefit: Income splitting in retirement

Our progressive income tax system levies higher tax rates as a person’s income increases. Generally, a household’s income tax bill will be minimized when two spouses’ incomes are equalized. That’s true whether you are in your working years or in retirement. The problem during your working years is that you can’t equalize by just giving away your current income to your spouse for current use.

However, current-you can equalize with future-you by giving/contributing some of your income to your RRSP. With the likelihood that you will require less income in your later years, this effectively shifts income down tax brackets. Better yet, if you expect your spouse to be at an even lower bracket, you can use a spousal RRSP to convert your current high income into your spouse’s future low income.

This does not mean that every allowable dollar should be contributed to a spouse’s RRSP. The idea is to equalize, not to swap positions, with a spousal RRSP being one way to get you closer to that happy medium.

How much can you contribute?

A person’s annual RRSP contribution room is 18% of the previous year’s earned income (to an indexed dollar maximum, which is $31,560 in 2024 ), plus unused room from previous years. If there are any contributions to a registered pension plan on the person’s behalf in the year, a pension adjustment will reduce that annual room.

Within that available room, there is no minimum amount or proportion that must be allocated to one’s own RRSP, nor any maximum that may be contributed to a spousal RRSP.

After age 71

Contributions can be made to an RRSP up until December 31 of the year that an annuitant turns 71. For your own RRSP, you can’t make any further contributions after you pass that year-end. However, you may still contribute to a spousal RRSP if your spouse is 71 or younger, no matter how old you may be yourself.

On death

Contributions cannot be made to an RRSP of a deceased person. However, a deceased person’s executor may make a spousal RRSP contribution from the estate in the year of death or within 60 days after the end of that year. The deduction for the contribution may be claimed on the deceased individual’s final tax return.

Non-qualified RRSP room

There are a few situations when special RRSP room can only be used for a taxpayer’s own RRSP. Even so, a spousal RRSP contribution may serve as a complement or substitute, depending on circumstances.

Commuting a registered pension plan

When leaving an employer, an employee has the option to commute the value of a registered pension plan (RPP) and roll it tax-free into a locked-in RRSP. If the commuted value is greater than the regulated limit for rollover, the excess amount is taxable in the year the pension is commuted. If the person has other unused RRSP room, the excess amount could be contributed to either the person’s own RRSP or a spousal RRSP to offset the tax.

Retiring allowance

A payment made in recognition of long service to a departing/retiring employee is taxable. However, for each year the person worked prior to 1996, $2,000 of the payment is eligible to be contributed to the person’s RRSP, plus $1,500 for each year employed prior to 1989. Such contributions do not require or affect existing RRSP room. If the person has other unused RRSP room, the non-eligible portion of the retiring allowance could be contributed to either the person’s own RRSP or a spousal RRSP to offset the tax.

Foreign pension

When a Canadian resident cashes out a foreign pension in a lump sum, the Canadian dollar equivalent is brought into income. However, special RRSP room is allowed in that year for the person to make an RRSP contribution up to the amount of that income inclusion. If the person has other unused RRSP room, the person could choose not to use the entire special RRSP room, instead allocating a portion of the cash to a spousal RRSP.

Canvassing more potential benefits

In addition to retirement income splitting, a spousal RRSP may be used to strategically manage tax in other ways. There are many considerations in determining whether and how to do this, with the main factors being the spouses’ current and future (expected) income levels and tax brackets, and the age difference between them.

Withdrawals in low-income years

In theory, a spousal RRSP can be used for income splitting at almost any stage of life. There is no legal requirement that a person be retired to take RRSP withdrawals, and in fact there is no formal definition of retirement in the RRSP rules.

One of the uses of a spousal RRSP could be as a standby reserve to bridge income during an unexpected employment gap, though preferably coordinated with a dedicated emergency fund. Alternatively, it could be an intentional part of a plan to manage a known upcoming low-income period, for example a planned work sabbatical or parental leave for the birth or adoption of a new child.

Still, care should be taken not to deplete a couple’s savings to the extent that their retirement may be put at risk. As well, the legal ability to take withdrawals does not change the fact that withdrawals are taxable, and possibly taxed to the higher income spouse, as discussed further on.

Participation in the RRSP Home Buyers’ Plan or Lifelong Learning Plan

Though an RRSP is designed for retirement savings, it may also be used to assist in the purchase of a new home or to pay for later life education. To participate in either program, one must be an annuitant of an RRSP.

- The Home Buyers’ Plan (HBP) allows up to $60,000 to be applied toward the purchase of a new home. With a spousal RRSP in place, this will double the amount to $120,000 available to a couple.
- The Lifelong Learning Plan (LLP) allows up to $20,000 to be applied toward education. The annuitant must be the student, so the existence of a spousal RRSP assures that each spouse may make use of the LLP.

Amounts taken out are not taxed if returned to an RRSP in the following years, in accordance with program rules.

Potential deferred RRIF conversion

All RRSPs must be matured by the end of the year that the annuitant turns 71. Maturing means either taking amounts into income, purchasing a registered annuity that makes annual income payments, or transferring to a registered retirement income fund (RRIF) – or a combination of these elements.

The application of this rule can be delayed by as many years that the annuitant of a spousal RRSP is younger than the contributor. That’s because RRSP closing/conversion is strictly dependent on the annuitant’s age, irrespective of who contributed.

Working with and around the pension income splitting rules

Under the pension income splitting rules, someone who receives eligible pension income (EPI) may split up to 50% of that amount with a spouse. This is achieved through a joint election made by the pensioner and the spouse when filing their annual income tax returns.

Under age 65

If the pensioner is under age 65, EPI is most often limited to RPP payments, though RRIF and annuity payments qualify if they come from a plan that was originally owned by a predeceased spouse. Otherwise, a pensioner must be 65 or over for RRIF and annuity payments to be EPI. Withdrawals taken directly out of an RRSP do not qualify as EPI at any age.

With a spousal RRSP, the couple can skirt around the age 65 criterion for RRIFs. Subject to the attribution rules discussed below, the annuitant/owner of a spousal RRSP may take withdrawals regardless of either spouse’s age. What’s more, the full amount will be taxed to the recipient, whereas the pension splitting rules require the pensioner to be taxed on at least 50% of the income before any amount may be split with a spouse.

Age 65 and over

Even if the pensioner is over 65 with the ability to split RRIF income, the existence of a spousal RRSP can provide greater flexibility. Per the last point in the paragraph above, a spousal RRSP gets around the need for a pensioner to receive taxable RRIF income first, before splitting with a spouse. That could be especially important in later years when a pensioner is receiving a greater portion of interest income in their non-registered portfolio, which may already be pushing the pensioner’s taxable income higher.

Consider as well that age 65 is when a person may begin Old Age Security (OAS). If a pensioner is close to the OAS recovery tax income threshold (See the article “OAS – Old Age Security” for details), then the benefit from splitting the RRIF may be offset by the clawback of future OAS payments. Facing that a prospect, a pensioner may instead decide to limit RRIF payments, with the unfortunate result that the couple may then be living a lifestyle below what is actually feasible. Meanwhile, that RRIF and its associated tax liability continue to grow. With a spousal RRSP in place, exposure to OAS clawback could be alleviated or avoided altogether.

Early withdrawals and attribution

Once a contribution has been made to a spousal RRSP, the annuitant/owner spouse is legally entitled to take withdrawals from the plan. The annuitant is taxed on those withdrawals, except when the withdrawal occurs in the year of contribution, or in one of the two immediately preceding taxation years. Withdrawals in that three-year period are attributed to the contributor. To be clear, attribution does not mean the contributor pays the annuitant’s taxes, but rather that the withdrawal is added to the contributor’s income, at a presumably higher tax bracket.

This attribution rule does not affect the annuitant spouse’s withdrawals from RRSPs to which he/she had been the only contributor. Such withdrawals are taxable to that annuitant/owner in the normal manner.

Contributions before year-end, or in the first 60 days of the year

Note that it is the year of contribution that matters, not the taxation year against which the contributor claims the deduction. To illustrate, a contributor is entitled to take a tax deduction when filing their 2023 income tax return, whether a contribution is made during 2023 or in the first 60 days of 2024. However:

- For contributions in the first 60 days of 2024, attribution may apply to withdrawals in 2024, 2025 or 2026.
- If instead a contribution had been made before 2023 year-end, the three-year attribution period would begin in 2023, and end in 2025 .

Multiple spousal RRSPs

One may wonder: Is it possible to get around the attribution rule by contributing to one spousal RRSP, while taking withdrawals from another? The answer is ‘no’.

The attribution rules cannot be avoided either by setting up multiple spousal RRSPs with one financial institution, or by spreading them across financial institutions. Attribution is based on contributions to any spousal RRSP, with the three-year look back rule applying to withdrawals from any spousal RRSP.

Commingling funds

A financial institution’s business rules may allow a spousal RRSP to be set up so that only the non-annuitant spouse may contribute, or both spouses may be allowed to contribute. As well, it may be established as a new account, as an addition to an existing spousal RRSP, or as a deposit to an existing RRSP of the annuitant.

In the last case, the contribution converts the account into a spousal RRSP, and it will always be treated that way thereafter. This is true even if later withdrawals exceed spousal contributions, and even if those withdrawals are attributed to the contributor spouse. It’s obviously important to be attentive to how contributions are arranged, as a misstep could seriously constrain the annuitant spouse’s ability to take non-attributable withdrawals in future.

Verifying tax slips, especially for online contributions

The tax slip for a spousal RRSP distinguishes which spouse is the contributor, and which the annuitant. Again, it is the former who gets the deduction, and the latter who owns the plan. When working with a financial advisor, a couple can confirm directly with the advisor that the contribution and tax slips align with their intentions.

Extra care should be exercised with online accounts, as it is generally necessary to be on the annuitant spouse’s connection to make the contribution. Some issues that may arise:

- The default setting may be for contributions to be recorded as being by that person to his/her own RRSP. If so, the annuitant spouse would get the deduction, not the intended higher income spouse.
- If the annuitant spouse does not have sufficient RRSP room, an over-contribution penalty would apply.
- Alternatively, if the higher income spouse is correctly identified as contributor, but the target account is the annuitant’s own RRSP, that account may unintentionally be converted into a spousal RRSP.

Review all elements of online transactions so that any necessary revisions may be made before the final click.

Ordering rules for withdrawal

When both spouses contribute, the expectation may be that withdrawals from spousal RRSPs will be proportional to contributions, or on either a first-in/first-out or last-in/first-out basis. On the contrary, all withdrawals in a year are deemed to be the contributor’s, up to the amount of his/her contributions in the three-year attribution period.

To demonstrate, assume the annuitant opens an RRSP with $5,000 in year one, to which the contributor adds $5,000 in year two. On a $6,000 withdrawal in year three, $5,000 is attributable. If the order is switched and the contributor initiates a spousal RRSP with $5,000 in year one, followed by $5,000 in year two from the annuitant, that $6,000 withdrawal in year three will result in the same attribution of $5,000 to the contributor.

Exceptions

Attribution does not apply in the following circumstances:

- Withdrawals occurring while spouses are living separate and apart;
- Withdrawals made during or following the year the contributor dies;
- An amount deemed to be received by a plan annuitant due to the annuitant’s death;
- Withdrawals in a year when either spouse is a non-resident of Canada;
- An amount transferred directly into another RRSP, or used to purchase an annuity that cannot be commuted for at least three years from the date it was purchased;
- An amount that is transferred to a defined benefit pension plan to buyback past service; and
- Amounts withdrawn from an RRSP in accordance with the rules of the HBP or LLP.

Repayments to the RRSP Home Buyers’ Plan or Lifelong Learning Plan

Both the HBP and LLP require that amounts taken out of an RRSP be repaid in the years following their use for the respective home or education purpose. Repayments need not be made to the same RRSP from which the funds originated, but must be to an RRSP of that same person as annuitant. This can provide some relief from the future application of the attribution rule, if withdrawals from a spousal RRSP are repaid to a non-spousal RRSP.

Repayments may not be allocated to a spousal RRSP of which the other spouse is the annuitant.

Any unrepaid amount is taxable to the annuitant in the year it was due. Fortunately, even if the repayment schedule begins within the three-year period related to contributions, attribution does not apply to missed repayments.

Conversion to RRIF

When a spousal RRSP is converted into a spousal RRIF, the three-year attribution rule continues to apply, but only to the amount above the annual RRIF minimum. Bear in mind that there is no RRIF minimum in the year that an RRSP is converted to a RRIF, so attribution applies from the first dollar of any RRIF withdrawals that year.

RRIF withdrawals may be based on the age of the annuitant or the annuitant’s spouse. Commonly, this is used to minimize the minimum RRIF withdrawal schedule for an older annuitant, by choosing the age of a younger spouse. However, it can also work the other way, with the annuitant of a spousal RRIF choosing the older spouse’s age, squeezing a little more out through a higher minimum that is not subject to attribution.

When attribution applies to spousal RRIF withdrawals, any attributed amount is not considered to be EPI for pension income splitting. The amount will be taxed to the contributor, even if the contributor is over age 65.

Withholding tax

Financial institutions are required to withhold tax on all withdrawals from RRSPs, and on the amount in excess of the minimum withdrawal for RRIFs. The annuitant will receive a tax slip showing total withdrawals for the year, and the amount of tax deducted/withheld.

The withheld tax is remitted by the financial institution to the Canada Revenue Agency (CRA), as a credit against the annuitant’s eventual tax due, and may contribute to a tax refund for the annuitant. The withheld tax cannot be used by a contributor spouse to whom any amount may be attributed.

The spouses must complete CRA Form T2205 “Amounts from a Spousal or Common-law Partner RRSP, RRIF or SPP to Include in Income.” Each attaches a copy of the completed form to their income tax return for the year.

Easing spousal loans – A CRA commentary offers repayment flexibility

Prescribed rate loans are a mainstay of spousal income splitting. A high-income spouse lends to a low-income spouse to invest in a non-registered portfolio, allowing investment income and associated tax to shift from the former to the latter.

So long as interest on the loan is paid according to the rules, it may remain outstanding indefinitely. As the portfolio grows, spouses may also be motivated to keep a loan going for another reason: If the whole portfolio must be sold to retire the loan, there may be an unwelcome realization of large capital gains.

But does the whole portfolio really have to be sold? Recent comments from the Canada Revenue Agency (CRA) suggest that loan retirement is more flexible and tax-friendly than may have been feared.

Recapping the rationale

Our progressive rate income tax system is based on the individual as the taxed unit. If you as a high bracket taxpayer try to work around this by making a gift to someone close to you, like a spouse, investment income on that gifted property will be attributed back to you. However, if this is done through a loan charging interest no less than the prescribed rate according to tax regulations, there is no attribution.

The prescribed rate is set quarterly, calculated as the average yield of Government of Canada 3-month T-Bills auctioned in the first month of the preceding quarter, rounded up to the next whole percentage. It is presently at 1%, its lowest possible rate, and will continue that way until at least March 2021.

The borrowing spouse is taxed on the investment income less interest paid, and in turn the interest is taxable to the lending spouse. The interest must be paid during the year, or no later than 30 days after year-end. As well, there must be an actual payment, meaning that it can’t just be a bookkeeping entry or further gift or loan from the lender.

Failure to comply with the rules at any point will taint the arrangement, such that attribution will apply for that year and on into the future.

Paying down or replacing loans

While the loan may remain outstanding indefinitely, there may be situations where it would be desirable to pay it off. For example, the borrower may inherit or otherwise come into a substantial sum. Arguably that money could be invested alongside the existing arrangement, but depending on what else is going on in their lives at the time, the couple may decide it’s best to retire the loan.

Another scenario is where there is an existing loan that was established while the prescribed rate was higher than at present. A lower interest rate would both increase the borrower’s net return and decrease the income inclusion for the lender. As the rules do not allow the couple to simply change the rate by stroke of a pen, the past loan must be closed-out before a new one can be advanced.

Assuming there’s no other money in reserve, the source to pay off the existing loan would have to be that same investment portfolio. Playing devil’s advocate (without casting aspersions on our tax authority), with anything short of full disposition, could it be argued that the borrower is still investing and earning off the original borrowed money? If so, would that then taint the second loan from the beginning?

Favourable CRA view on refinancing

At the Canadian Tax Foundation conference in October 2020, the CRA was given the scenario of an original $100,000 prescribed rate loan at 2% that had grown through investment to $200,000. It was asked about the implications if the borrower sold half the investments to retire the loan, followed by a new $100,000 loan at 1%, also to be invested.

With respect to potential attribution on the continuing investment from the original loan, the CRA official quoted a section from IT-511R that allows exemption from attribution once “the loan is repaid” – Nothing more was said on the point. With respect to investment of the second loan proceeds, it was acknowledged that it could similarly qualify for the exemption from attribution, as long as all other conditions are satisfied.

Helpfully, CRA further mentions the attribution rule where a new loan is used to pay an existing loan. The response expressly notes that this rule “would not technically apply in this situation as the proceeds from Loan 2 are not used to repay Loan 1.”

This is good news for spouses looking to refinance a loan at a lower rate while keeping from triggering excessive capital gains on appreciated investments. As CRA itself highlighted, form and process matter here, so the couple should take care to execute the steps in the approved order, and document accordingly.

Insurance premiums could retroactively disqualify rollover to spousal trust

At issue

Life insurance is a regularly-used estate planning tool, often quantified in part to satisfy a capital gains tax liability on death. As capital property can transfer – or ‘rollover’ – between spouses at adjusted cost base (ACB), insurance proceeds for this purpose would not be required until the second death of the two, and the insurance may be structured with that in mind. (In this article, the term spouse includes a common-law partner.)

Trusts are also central tools in wealth and estate planning. A transfer of capital property to a spousal trust can (but does not have to) occur on a rollover basis. As long as the trust does not dispose of that property during the spouse-beneficiary’s lifetime, capital gains recognition will be deferred until that person’s death.

But where life insurance and a spousal trust are married together (pun intended), it could lead to a retroactive negative tax result.

Income Tax Act (ITA) Canada – Sections 70(6) and 73(1.01)

The main rules enabling a rollover to a spousal trust are in ITA s.73(1.01) for inter vivos (lifetime) transfers, and ITA s.70(6) for testamentary transfers. For present purposes, the requirements are essentially the same either way. The result of the successful application of the rules is that the transferor has deemed proceeds equal to his or her ACB, and the trust is deemed to have acquired the assets at that same amount.

In addition to both the parties having to be Canadian residents at the time of the transfer, the trust must comply with ongoing rules regarding income entitlement and access to capital. Specifically,

The spouse-beneficiary must be entitled to all income of the trust during his/her lifetime; and
No-one but the spouse-beneficiary may receive or otherwise obtain the use of any of the income or capital of the trust before that person’s death.

Carefully reading the second proviso, the spouse-beneficiary does not have to be entitled to the capital in order for the rollover to apply. A typical application might be a second-marriage spouse-beneficiary having use of a house, cottage or other capital for life, with the capital to be distributed to the first-marriage children upon the beneficiary’s death.

2014-0529361E5 (E) – Spousal trust & life insurance, November 16, 2015

This CRA letter deals with the use of trust assets to pay life insurance premiums, where the proceeds of the insurance will be paid to a policy beneficiary.

At issue is the constraint on access to the capital of the trust. Though the contents of the taxpayer’s letter are not quoted directly, the CRA letter begins with an acknowledgement of common ground “that the relevant legislation does not contain a requirement that the spouse “benefit” from the trust while alive.” However, it goes on to raise the concern whether someone other than the spouse-beneficiary may be obtaining the use of the trust capital or income.

The taxpayer’s argument appears to have been that as nothing is received before the spouse’s death, the premium payments should not be considered as property used by the residual beneficiaries. This position is rejected, and instead characterized by the CRA as the use of trust property to establish the residual beneficiaries’ rights to the funds from the policy, the realization of which will simply occur after the death of the spouse.

The upshot is that payment of such insurance premiums would disqualify the trust from ever being a spousal trust eligible for a capital property rollover.

Notably, it took the CRA a year-and-a-half to respond to this letter, which is a bit longer than usual. The opening states that the “submission received careful consideration”, an unnecessary but arguably telling indication that extended time was required to grapple with the merits of the arguments. As well, the closing advises that the submission was also forwarded to the Department of Finance, the responsible legislative department (as compared to the CRA being an administrative body).

Practice points

Life insurance remains a useful tool for dealing with tax liabilities, but its ownership, funding source and beneficiary designations must be carefully considered in light of CRA’s position in this letter. Any contemplated workaround (for example a parallel trust for the insurance alone) should be reviewed by legal and tax advisors to be sure the problem is adequately addressed without causing other undesirable consequences.
Some insurance-based concepts, for example an insured annuity, may be positioned as a means to improve investment returns. Though they may be shown not to harm a spouse-beneficiary – and possibly even to increase lifetime income – such concepts would appear to be problematic for spousal trusts.
CRA’s open notice that it was sharing the submission with the Department of Finance may be a ray of hope that this may not be the final word on the issue.