Dale Jackson

Personal Finance Columnist, Payback Time

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In the rush to meet the March 1 registered retirement savings plan (RRSP) contribution deadline, it’s easy for long-term tax strategies to be overlooked. 

The short-term advantage of a tax refund in the spring could pale in comparison with a lifetime of tax savings by splitting income through measures such as a spousal RRSP and even a tax-free savings account (TFSA). In some cases, the tax bill from neglecting an income splitting strategy could well exceed the savings from a contribution now.     

The March 1 deadline also applies to spousal RRSP contributions, but it is important to note that it only applies if you want to deduct the contribution from your 2021 income. Like a regular RRSP, spousal RRSP contributions can be made any time and claimed in future tax years. 

That should ease some of the pressure for contributors who want to consider a long-term tax strategy or speak with a tax professional.

HOW INCOME SPLITTING WORKS

Canadians love RRSPs because they often result in a tax refund after filing their annual tax returns. While it may seem like a windfall, those contributions and any gains they generate through investments over the years are fully taxed when they are withdrawn - ideally at a low marginal rate in retirement.

If too much is contributed, or those savings grow beyond expectations, plan holders will eventually be forced to make minimum withdrawals at a higher marginal rate; possibly higher than the tax savings when the initial contributions were made. If those withdrawals reach a certain threshold, plan holders can also face a reduction in Old Age Security (OAS) benefits. 

Income splitting can save countless tax dollars in cases where the taxable income and resulting marginal tax rates from one spouse is higher than the other. It permits one spouse who is normally taxed at a higher rate to shift their taxable dollars to their spouse, whose income is taxed at a lower rate.

As a general rule, a higher income spouse can split up to 50 per cent of their pension income with a lower income spouse in a lower tax bracket when they turn 65. Income splitting is not permitted for those who retire earlier unless the income comes from certain life annuity payments or money received from the death of a spouse. 

PRE-RETIREMENT INCOME SPLITTING STRATEGIES

The key to avoiding high taxation in retirement is to balance savings between spouses as much as possible long before retirement.

A higher income spouse can do that by making regular contributions to a spousal RRSP in the name of the lower income spouse. It allows the higher income spouse to deduct the contribution at their higher tax rate like a regular RRSP, and the lower income spouse to eventually withdraw it at a low tax rate. 

One warning: spousal RRSP contributions are deducted from the total allowable contribution limit of the higher income spouse, so it’s important to keep track.

Tax-saving measures can also be taken between spouses before and after retirement by shifting as many tax credits and deductions as possible to the higher income spouse.

SPLITTING INCOME WITH A TFSA

The total tax bill after retirement can also be greatly reduced by diverting some savings to a tax-free savings account before retirement. While TFSA contributions can not be deducted from taxable income (like an RRSP), TFSA withdrawals are never taxed.

That means a well balanced mix of RRSP and TFSA savings could allow retirees to withdraw RRSP savings at a low rate and top up additional income from their TFSAs.