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How to use income splitting and a spousal RRSP during retirement - DFSIN - SFL

How to use income splitting and a spousal RRSP during retirement

Certain strategies could help you increase your retirement income… without necessarily having to save more during your working life. How? Follow this guide. 

February 27, 2023

Does the term “income splitting” mean anything to you? It’s a tax strategy that can allow a couple, under certain circumstances, to optimize their net income during retirement. There are two main ways of putting this strategy into effect: one that can be adopted upon your retirement, and one that works best when set up years in advance: the spousal registered retirement savings plan (spousal RRSP). 

A five-point explanation. 

Beginning of an infographic demonstration explaining how income splitting can be an effective strategy for increasing one's retirement income.Point 1: What is income splitting? A strategy that enables an individual whose income is higher than his or her spouse's to transfer part of that income in order to reduce the level of taxation..   Example Claude has retirement income of:            $100,000. Dominique has retirement income of: $25,000. Total: $125,000.  Option A: No income splitting. Claude pays $22,958 in taxes and Dominique pays $2,290. They end up with after-tax income of $99,752. Option B: With income splitting. Dominique and Claude both have income of $62,500. Each one pays $11,153 in taxes. So they end up with after-tax income of $102,694, for a gain of $2,942 thanks to income splitting.Calculation for illustrative purposes only. The tax rates used here are the combined federal and provincial rates in effect in Ontario for 2022. Results will vary based on province and several other factors.

Point 2: When is it advantageous to use income splitting during retirement? For income splitting to be worthwhile, there must be a significant difference in income between spouses. They need to be in different tax brackets. For example: One spouse has higher pension income. One spouse continues to work after the other retires. One spouse was able to save more because the other had a lower-paying job; or stayed home with the kids; or went back to school; or had health problems; etc..

Point 3: How can retirement income be split? There are two main ways. 1. Pension income splitting. This is a simple tax provision to use when filling out your tax return. The income is simply attributed to the spouse for tax purposes. 2. Spousal RRSP. This is an RRSP in the name of the lower-income spouse, where the contributions are made by the other spouse. The savings and resulting income effectively belong to the lower-income spouse. This must be set up many years before retirement.

Point 4: How does a spousal RRSP work? a. A spousal RRSP is opened in the name of the spouse with the lower income. b. The spouse with the higher income makes the contributions. c. At retirement, there will be less difference in savings between the two spouses, allowing for a better balance of incomes. So Claude contributes to the spousal RRSP on behalf of Dominique. Claude's contribution limit applies. And it is Claude who can claim the tax deduction. However, Dominique owns the RRSP, controls the investments and will be taxed on withdrawals. Claude's and Dominique's personal RRSP are subject to the normal rules. In short, Claude gets the tax deduction and must have enough RRSP contribution room. Dominique owns and controls the RRSP and will be taxed on the withdrawals..

Point 5: Why use a spousal RRSP if you can split pension income anyway? It can also be used to buy a first home through the Home Buyers' Plan (HBP). It can reduce the Old Age Security benefit clawback. AND it allows you to continue making contributions after age 71 if the spousal RRSP owner is younger than 71 . Be aware that rules apply as to when withdrawals can be made (attribution rules). The spousal RRSP has some advantages over pension income splitting.

Talk to your advisor about your income-splitting options during retirement.

The following sources were used to prepare this article. 
Desjardins, “Contributing to your spouse's RRSP.” 
EY, “2022 Personal tax calculator.” 
Intuit TurboTax, “Spousal RRSP: Contribution & Withdrawal Rules.” 
Les Affaires, “Un REER de conjoint aide les couples à économiser.” 
MoneySense, “A guide to spousal RRSPs for married and common-law partners.” 
Retire Happy, “The proper use of spousal RRSPs.” 
Vancity, “Spousal RRSPs: still useful?”