RRSPs: Contributing - Part 2

  1. RRSPs: Introduction
  2. RRSPs: The Benefits
  3. RRSPs: Eligibility
  4. RRSPs: Contributing - Part 1
  5. RRSPs: Contributing - Part 2
  6. RRSPs: Investment Eligibility
  7. RRSPs: Growth
  8. RRSPs: Withdrawals
  9. RRSPs: RRIFs
  10. RRSPs: Registered Plan Strategies
  11. RRSPs: Conclusion
Now that we have explored some of the basics of RRSP contributions, let's get into some of the details regarding how a married couple can take full advantage of contribution limits through income splitting. In certain circumstances, you are allowed to contribute to your spouse's RRSP. This contribution, known as a "spousal contribution", is generally done to take advantage of income splitting.

Income Splitting

If one spouse is in a different tax bracket than his or her partner, RRSP contributions can be used to lower the total amount of taxes a couple must pay. The greater the difference between the two spouses' incomes, the greater the advantage of using RRSPs to income split. The opportunity to use RRSPs as a way to income split also applies to common-law relationships. However, the total amount of money that each partner contributes to both his or her own RRSP and that of the spouse cannot exceed that individual's personal contribution limit.

Let's go back to our earlier example:

Brad's wife earns $150,000 a year and Brad earns $35,000. Therefore, Brad's wife has a contribution allowance of $22,000 and Brad is allowed to contribute $6,300. (The calculations we used to come up with these figures can be found in the previous section.) If the couple only has $10,000 available for RRSP contributions for the year, they will save money on taxes if Brad's wife contributes to his RRSP, rather than to her own. Here's how it works:

Example - Before Making an RRSP Contribution:

Brad\'s notice of assessment says that he owes the government $5,250 in income tax for the 2010 tax year. Remember that Brad makes $35,000 per year, so his income tax liability is equal to his income multiplied by his tax rate ($35,000 x 15%) = $5,250.
Brad\'s wife\'s notice of assessment says that she owes the government $33,544. Again, she makes $150,000 per year, so her income tax liability is equal to 15% of the first $40,970 she earns, plus 22% of income over $40,971 but lower than $81,941, plus 26% of income over $81,941, but less than 127,021 plus 29% on any income over $127,021. For Brad\'s wife, this works out to $40,970 x 15%(=($6,146))+ 22%($81,941-40,971(=$9,013)) + 26%($127,021-81,941 (=$11,721)) + 29%($150,000-127,021 (=$6,664)) for a total of $33,544. (These figures have been rounded to the nearest dollar).
If you add the two tax liabilities together, the couple owes the government $38,794 in income tax for the year ($5,250 + $33,544 = $38,794).

As we noted earlier, Brad's maximum RRSP contribution is $6,300 and his wife's maximum contribution is $22,000. Combined, the couple saved $10,000 in the 2010 tax year, which they will contribute to their RRSPs.

Example - Before Income Splitting:

If the couple equally divides the $10,000 that they\'ve saved to contribute to their RRSPs, Brad gets $5,000 and his wife gets $5,000.
Under this equal arrangement, Brad will then owe the government $4,500 in income taxes. Recall that Brad owed $5,250 and that RRSP contributions are tax deductible from income. That means that instead of Brad being taxed on his full income, he is taxed on his income less his RRSP contribution. Brad\'s income was $35,000, but after his RRSP contribution deduction ($5,000), his taxable income becomes $30,000 ($35,000 - $5,000). His total income tax payable for 2010 then becomes equal to 15% of $30,000 which is $4,500 (15% * $30,000 = $4,500).
If the couple decides not to split their income, Brad\'s wife will owe the government $26,880 (the amount of tax she pays in the first $127,021 income she earned) + 29% * ($150,000 - $5,000 - $127,021) or $32,094. Recall that RRSP contributions are deducted from earned income before income tax is applied. In this case, her earned income will be $150,000 minus her $5,000 RRSP contribution. Because she is in such a high tax bracket, Brad\'s wife has to pay the government $26,880 plus 29% of every dollar she earns over $127,021. Her RRSP contribution, however, is only deductible from the amount she earns over $127,021.
Combined, the couple will have to pay Brad\'s $4,500 tax liability plus his wife\'s $32,094 tax liability for a total of $36,594. The couple\'s $10,000 RRSP contribution, therefore, saved the couple $2,200 ($38,794- $36,594) in taxes for the year.

Had the couple decided to employ an income-splitting technique, they could have saved some of the money that they owe to the government in taxes, even if they made the same $10,000 contribution to their combined RRSP savings.

Example - The Benefits of Income Splitting:

Brad\'s wife could have made the entire $10,000 RRSP contribution for the couple. Brad would contribute $0 to his RRSP, but the couple would contribute $10,000 collectively to his high-earning wife\'s RRSP.
The result is that Brad\'s wife pays $26,880 + 29% * ($150,000 - $10,000 - $127,071) or $30,629 in taxes. As we mentioned before, RRSP contributions are deducted from taxable income, so her tax liability is significantly reduced from the previous $32,094 she would have owed the government if she had only contributed $5,000 to her RRSP.
Because Brad pays so much less income tax than his wife, we\'ve used his lower tax bracket as an advantage. Nothing will be contributed to Brad\'s RRSP, but that\'s all right, because he\'s only liable to pay 15% of $35,000, which equals $5,250.
If the couple uses the income splitting technique, Brad and his wife will only pay $30,629 + $5,250 = $35,879 in taxes, a reduction from the $36,594 they would have paid had they equally divided the $10,000 RRSP contribution between the two of them.

If Brad and his wife had been smarter about their combined income and investments, Brad could have made a spousal contribution to his wife's RRSP. Simply claiming a spousal contribution would have resulted in the couple saving a combined $649 in tax. That's in addition to the money they've already saved in tax by deciding to invest in an RRSP. All they had to do was fill out a form. The only difference between the two examples is that Brad claims a spousal contribution!

Tax Owed Before Income Splitting and Contributions Tax Owed after RRSP Contributions without Income Splitting Tax Paid after Income Splitting by making a Spousal Contribution
Brad $5,250 $4,500 $5,250
Brad\'s Wife $33,544 $32,094 $30,629
Combined $38,794 $36,594 $35,879

RRSPs: Investment Eligibility