Happy Valentine’s Day, honey – RRSP deadline coming is up

Valentine’s Day is coming up, and so is the deadline for Registered Retirement Savings Plan (RRSP) contributions. What could be better than the gift of a spousal RRSP contribution? OK. Maybe I’m saying that a bit tongue-in-cheek. A spousal RRSP may not be the sexiest gift you can give your valentine, but it’s still a great thing to consider.

You know how an RRSP works, but just in case, here’s a recap. You put $10,000 into your RRSP and get a tax deduction for $10,000. That deduction reduces your overall income and, consequently, your tax bill. The tax savings in BC could be anywhere up to $5,350 depending on your income bracket. When you take it out later (usually bit by bit in retirement), you will pay tax on the withdrawal. But if you are in a lower tax bracket, as is often the case for retirees, then you will pay less tax than you otherwise would have. Plus, you will have benefitted from all those years of tax-deferred income.

A spousal RRSP works similarly, except that you place the money into your spouse’s RRSP. It’s counter-intuitive, but if it’s designated as “spousal”, you still get the tax deduction. It’s your RRSP room that gets used (so again, you get the deduction), but when it’s withdrawn, as long as it’s at least three years after the last spousal contribution, it will be taxed in their name. This may be useful in many situations, but particularly if you expect to be in a higher tax bracket than your spouse.

One important thing to understand is that it will now be legally owned by your spouse, so they have final say over how to invest it and any other decisions. This includes decisions of who the beneficiary is, when and how much to withdraw, and when to convert it to a Registered Retirement Income Fund (RRIF). By placing the funds into a spousal RRSP, you are irrevocably gifting it to your spouse. 

Spousal RRSPs can make sense in many situations, but in some rare circumstances they can be used in an even more powerful way. Let’s take a look at a  real-life example:

Wilma and Fred had worked with an investment advisor in the past, but never a financial planner. When they came to us, they explained they had been burned in the past by accidental RRSP and TFSA over-contributions and resulting penalties. Wilma and Fred were pleased to discover that we took charge not only of their investment strategies, but also their contribution strategies.

In an ironic twist of fate, a few years later we informed Wilma and Fred that purposeful over-contribution at the end of the year would make sense in spite of the expected resulting penalty. Here’s why:

In the same year that Wilma turned 71, Fred had an exceptional high-income year and was expecting a repeat for the following year. Wilma’s income was very low, so we wanted to get as much money as possible into her RRSP. This created the perfect storm for a rare over-contribution strategy for those turning 71.

All RRSPs must be converted to RRIFs (or annuities or cashed in) by December 31 of the year that a person turns 71. After New Years’ Eve, no more money can be contributed to an RRSP (or spousal RRSP) in their name. But sometimes you want to push the limits and maximize how much is in those plans.

There is a three-year attribution rule that often makes it not worthwhile to place money in a spousal RRSP and withdraw it prior to the three years. However, there is an exception for the minimum amount required to be withdrawn if the RRSP has been converted to a RRIF.

So back to our example. In December, Fred contributed the maximum allowable limit of Wilma’s spousal RRSP, not just for the current year but for the following year as well. We worked with their accountant to determine his RRSP limit for the subsequent year and determined that total to be $26,000. We made the contribution in December because Wilma wouldn’t have an RRSP come January, so we could limit the penalty to only one month of over-contribution.

The results were as follows: Due to their tax bracket, Fred saved $12,948 in taxes (49.8% multiplied by $26,000), but he would have saved that even if he had put it into his own RRSP, so let’s ignore that for now.

Fred had to pay an over-contribution penalty of $240, because he didn’t technically have the room in December. If we had waited until January, he would have the room but not the option of contributing to Wilma’s spousal RRSP meaning we had to do it in December, thus incurring the one-month penalty.

An extra $26,000 went into Wilma’s spousal RRSP, which was immediately converted to a RRIF.

Wilma’s minimum payment on the $26,000 is $1,373. For three years, we need to keep her payments to the minimum to avoid triggering attribution, but after that the sky is the limit.

Since Wilma’s now in a 0% tax bracket, we’ve shifted their money from a 49.8% tax bracket to a 0% tax bracket. Ultimately, if we can manage to pull all $26,000 out tax-free, we’ve saved Wilma and Fred’s family a total of $12,948 in taxes with the small cost of a $240-over-contribution penalty.

Not all strategies are this effective, and most individuals don’t fall into such a perfect storm scenario to take full advantage of these strategies, but it’s always worthwhile to see if your situation fits into any unique special categories.

Plus, giving money to your spouse is never a bad idea. Just maybe buy them some flowers, too.

Arnold Machel, CFP® lives, works, and worships in the White Rock/South Surrey area. He is a Certified Financial Planner with IPC Investment Corporation and Visionvest Financial Planning & Services. Questions and comments can be directed to him at dr.rrsp@visionvest.ca or through his website at www.visionvest.ca. Please note that all comments are of a general nature and should not be relied upon as individual advice. The views and opinions expressed in this commentary are those of Arnold Machel and may not necessarily reflect those of IPC Investment Corporation. While every attempt is made to ensure accuracy, facts and figures are not guaranteed.  

 Arnold is now accepting a limited number of invitations to speak for the 2022/23 calendar years. If you are interested in having him speak to your congregation or other group regarding money matters, please contact us at admin@visionvest.ca or (604) 542-2818 with your preferred date and time.