Income Splitting in Retirement
Spousal RSP's One Option to Consider
(December 2004)
By Paul Barton, CFP
Sam and Donna have been enjoying retirement for a few years now, spending one or two days each week on the golf course. While raising their family, Donna chose to be a stay-at-home mom. Sam had a high paying job and a reasonable pension to go with it. Throughout their marriage, Donna looked after the family finances and was accustomed to Sam "bringing home the bacon." In retirement, their financial roles are somewhat the same as Donna still looks after the finances, with Sam's pension now the main source of income.
When Sam entered retirement, he noticed a slight decrease in his overall income, which he fully anticipated and prepared himself for. One of the things that bothered Sam was that the amount of income tax he was paying in retirement was not much different than what he was paying when he was working. He wondered if there was anything he could have done prior to retirement to help ease his income tax situation now.
A common goal for many people is to minimize the amount of taxes he/she pays to the government. Paying less tax means you get to keep more of what you earn. Finding ways to reduce taxes, within the parameters of the tax laws, is a perfectly acceptable financial goal to have. Tax evasion, on the other hand, is not a good financial strategy to employ…doing so is against the law and could land you in jail.
As people plan for retirement, regardless whether one has 10 years before retiring or 25 years, it's best to start looking at retirement income sources sooner rather than later. Income sources in retirement generally consist of company pension plans (if applicable), government pension programs and individual retirement savings. Two reasons come to mind with respect to why you may wish to look ahead at your retirement income picture:
- Knowing how much income you will need in retirement, especially if such an exercise is done well in advance of your planned retirement date, will help you determine if you are on target to meet your retirement plans. If you are falling short of your intended goal, knowing this early will enable you to make choices and changes to how much money you are setting aside for retirement.
- Keeping taxes in mind, you could look into whether or not income-splitting strategies would be appropriate for your situation. For example, if a retired couple needs $50,000 annually to meet expenses and planned lifestyle choices, ideally it would be better if each spouse had an annual income of $25,000. In this situation, each spouse would be taxed at a lower tax rate than if one spouse had all $50,000 in his/her name.
One way many families in Canada achieve income splitting in retirement is by establishing a Spousal Retirement Savings Plan (Spousal RSP). To illustrate…Kate has been working as a teacher for many years and will receive a nice pension when she retires. Her husband Peter is self-employed and does not have a company pension plan.
The Canadian tax system allows individuals to claim contributions to retirement savings plans as deductions on his/her tax return. With Kate having a higher income than Peter, for years she has been contributing to a Spousal RSP in Peter's name, which allows her to claim the RSP contribution as a deduction on her tax return. Be aware that if Peter were to withdraw the contribution Kate makes to the Spousal RSP within three years of the contribution being made, tax liability would attribute to Kate. This is known as the "Attribution Rule."
Since the money contributed to the Spousal RSP belongs to Peter, he will use this money for retirement income purposes sometime in the future. By using the Spousal RSP strategy, when Kate and Peter reach retirement, they anticipate that part of their retirement income will come from Kate's pension and part will come from Peter's Spousal RSP, thereby achieving an element of income splitting to minimize taxes in retirement years.
When considering retirement planning, be mindful of income tax implications in retirement. Meeting with a licensed financial planner can help you determine if an income splitting strategy is right for your situation.
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