Everyone would like to pay less tax. With many couples, the partner with the higher income invests more money into a Registered Retirement Savings Plan (RRSP). Investing in this product allows for tax deferral and building a retirement nest egg. At retirement, this could put one partner in a higher tax bracket while the other ends up with little or no retirement savings and income.

A spousal RRSP is a tax-smart strategy that many couples use to equalize their income so they pay less tax in retirement.

Here is how a spousal RRSP works: The higher income partner applies some of his or her RRSP contributions to the lower income partner’s RRSP and claims the tax deduction on the contributions. When the lower-income partner, who is the legal owner of the plan, withdraws that money (as long as it has been three years since the last contribution was made to the spousal account), the money qualifies as income for the lower income partner and will be taxed at a lower rate.

Any RRSP contribution you make can go into an RRSP in your name, your spouse’s name, or be split in any way between the two plans. As a retirement planning strategy, contributing to the partner’s plan that has a lower income in retirement is a smart way to reduce the combined tax bite during retirement years. This also allows the higher income partner to claim the contribution deduction thereby reducing tax paid.

Consider a retired couple where one partner has retirement income of $50,000 and the other has $10,000 (for a total of $60,000). Their total tax bill will be $20,600 (assuming a 25% tax rate on the $10,000 and 35% on the $50,000). However, if the partners split their income, so they each have $30,000 in retirement income, and are now both in the lower tax bracket, their combined tax will be $15,000 (assuming a 25% tax rate). That’s a family tax savings of $5,000!

Here’s another benefit. A spousal RRSP could also help you at retirement to reduce the “clawback” of your Old Age Security (OAS) benefits. For the 2009 tax year, the clawback is 15% of net income in excess of $66,335 and 100% if net income reaches $107,692 (per individual, not family). By splitting retirement income, the net income for each person will be less, thus reducing the chance of a clawback of government benefits.

To be eligible for spousal contributions, the spouse must be legally married to the contributor or have a common-law relationship as defined under the Income Tax Act. The process of setting up a spousal RRSP is similar to setting up a regular RRSP – it is simply a matter of naming your partner as the holder of the plan.

As with any good tax planning strategy, there is a tendency for the federal government to want to make changes with it, and spousal RRSPs are no exception. Take a close look at your combined retirement income or future retirement income today, and set up a spousal RRSP while you can.

February 5, 2010