For most millennials, retirement is the last thing on their mind. Between dating, marriage, babies, cars and investments – retiring just feels like a lifetime away. For those lucky enough to put some savings aside, Canada has some really great programs in place to help you maximize and achieve your retirement goals. These programs are designed to encourage savings at a young age by offering immediate tax incentives and minimizing the impact of capital gains.

In Canada, we have two key programs – Registered Retirement Savings Plan (RRSP) and Tax Free Savings Account TFSA. These are similar in nature to your 401(k) and Roth IRA in the US. I get asked all the time which is the better vehicle for savings, and to be honest, there is no simple right answer. Both RRSP and TFSA are amazing vehicles that both carry their own set of benefits. Which way to go is really dependent on the individual, their current financial position, and finally, their future goals. We’ll comb over the benefits of each and how I’ve used them to my advantage in a future post.

For the sake of this discussion, we will focus strictly on Spousal RRSP’s and why it is an important extension of the overarching RRSP program. I have been a regular contributor to my RRSP for years, but I didn’t realize the importance of this until only a few years ago when I did some portfolio rebalancing. There was a significant disparity between my wife and my investment portfolios, which could have been avoided had I read this post 10 years ago. Of course, if you are reading this now, the hope is 1. you know what an RRSP is, and 2. you have a spouse.

Registered Retirement Savings Plan (RRSP)

An RRSP is simply a vehicle to reduce your annual taxes through savings contributions. As per the CRA, “any income you earn in the RRSP is usually exempt from tax as long as the funds remain in the plan“.

This matters for the contributor since you can lower your immediate tax bracket in the short term by simply allocating your money towards a registered savings fund. The money in the savings fund can continue to grow tax free until you are ready to retire, at which point you simply pay taxes on the amount you choose to withdraw. You are essentially deploying and investing pre tax money with the promise to pay taxes at a later date when you retire and are earning far less income. From a very high level, a RRSP can be looked at as an efficient way of balancing out your life time tax payments from higher earning years to lower (or $0) income years.

It is worth mentioning that consistent contributions combined with compound growth over decades is really one of the best vehicles to wealth there is.

Spousal Contributions

A spousal contribution allows a higher income earner to contribute to their spouse’s RRSP account using their own personal contribution limit. Hence, the higher earner receives the tax break in year by lowering their income through contribution, however the funds are distributed, owned and deferred within their spouses account.

Why This Matters

You may wonder at first glance – why would you use your contribution room and give your spouse the money? Well first of all, they are your spouse so they own half of what you own anyways. Secondly, by doing this you are effectively tax planning for the future in the most efficient manner. Income splitting rules have really evolved here in Canada over the last ten years with Spousal RRSP’s being one of the few remaining ways to do it.

Let me use an extreme example to illustrate the benefits of balancing your family RRSP accounts. John has $1,000,000 in RRSP funds at retirement, and Alice has $0. Upon retirement, it is determined that the couple requires $100,000 a year in spending money. Since we have already mentioned that tax is paid upon withdrawal, it is understood the more money you draw from your account, the more taxes you will be required to pay. Hence in it’s simplest form, the optimal withdrawal rate to minimize the tax owed by each person is to minimize the amount withdrawn. Withdrawing at a 50/50 rate achieves this goal. In the scenario above, that would mean $50,000 from each account per year.

While retirement may feel a lifetime away, planning for this eventuality today will go a long way in determining how much of your withdrawal actually stays in your pocket. If you are simply starting off your RRSP, or have very balanced family RRSP accounts, then spousal contributions may not matter just yet. However, I hope that by reading this you are at least aware of potential savings down the road so that when the time comes, you don’t make the same mistake I did.

Getting Set Up

If this form of income splitting matters to you today, I highly suggest you reach out to your Accountant or contact your existing Registered Account Brokerage and speak to one of their support agents. Effective planning today will save you potentially tens of thousands a few short decades from now.

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