RRSP income splitting strategies

The primary objective of income splitting is to reduce your tax liability as a couple and as a family.   Pensioners are now able to split qualified pension income, but before you take information to your accountant you may want to check that you are considering all strategies available and that your income will qualify.

Know the Rules

People should know that Registered Retirement Savings Plan withdrawals are not eligible to be split with your spouse.  One way for people aged 65 or older to make this income eligible for pension splitting is to convert all or a portion of their RRSP to a RRIF, which is eligible for pension splitting.

Assuming that you have eligible pension income to split, you should also be looking at how this affects both tax situations.  You should be aware of what will end up happening from a tax standpoint with this shift of income from the higher income spouse to the lower income spouse.  A spouse that normally may not have had much income suddenly will have income.

Does this create a planning opportunity?  At the same time that pensioners are allowed to income split they have increased the age for mandatory RRSP conversions to a RRIF.  Pensioners that income split may have unique strategies that didn’t exist last year.  In many cases, one member of the household may have income eligible to be split of $60,000 and a spouse that has little to no income.

For those people who feel like deferring tax a little further may want to consider an RRSP contribution by the lower income spouse.  This strategy will involve you speaking with your accountant before February 29 and may be suitable in the case where the lower income spouse has not been able to utilize RRSP deduction limit.

Here’s an illustration to make the point:

John and Karen Garmin were married 37 years ago and both are 61 years old.  At the end of last year, John took early retirement.  He has worked in a consulting capacity part time over the last year.  John has received approximately $60,000 in pension income and $25,000 in other investment income and employment activities.

John has elected to transfer $30,000 of his eligible pension income to Karen.  This reduces John’s taxable income to $55,000. Karen works part time and has annual employment income of approximately $15,000.  With the transfer of pension income, Karen’s total income is expected to be $45,000 for 2007.  Over the last 37 years Karen has worked part time and raised three children.  Working part time she has slowly accumulated a nice size RRSP contribution room.

Prior to the pension income splitting rules it never made sense for Karen to contribute to an RRSP based on her previous income of $15,000.  Karen brought us her 2006 Notice of Assessment and we noticed $29,200 in RRSP room.

We discussed with Karen that she is now in a better position to contribute to her RRSP.  She also mentioned that she planned to work for four more years.  The $15,000 that Karen earns annually is accumulating $2,700 new room each year.  Both John and Karen have significant savings in the bank.  We recommended that Karen plan to contribute $10,000 annually for the next four years to defer tax further.

Other strategies involve a little more planning and will result in splitting income in the future.  A good example of one strategy for younger couples is a spousal RRSP.  In the past, this was one of the best income splitting strategies available for couples.  The spouse with the higher income can make a spousal RRSP contribution to a plan in the name of the lower income spouse.  The higher income spouse receives the deduction however the funds accumulate for the benefit of the lower-income spouse.

We still like spousal RRSPs, even after the pension splitting announcement.  Some people may feel that spousal RRSPs will no longer be applicable now that pension splitting is allowed.  Unless you can predict your future we would disagree.

There may be an opportunity for you to retire at a younger age than expected.  Possibly you will need some funds from your RRSP for emergency purposes before the age of 65.  Certainly we cannot predict what the government will do in the future.

These are just a few reasons why a spousal RRSP may still make sense.  One component to a spousal RRSP that you should be aware of are the attribution rules.  The attribution rules apply if withdrawals are made from the spousal RRSP in the year of the contribution and the following two years.

Here’s another illustration:

Mary works as a lawyer and earns approximately $90,000 a year.  Her husband Bill is currently earning approximately $20,000 a year working part time and also attending university.  Mary already has accumulated significant savings both registered and non-registered.   Mary also anticipates that she may receive a large inheritance in the next 10 years.  Based on their situation we recommended that Mary contribute to a spousal RRSP for Bill.  Mary would still receive the tax deduction and Bill would begin accumulating savings for retirement.