RRSPs & Taxation

RRSP deductions do more than save you income taxes

First and foremost, RRSP deductions result in tax savings based on your marginal tax rate.

Since this deduction reduces your net income for tax purposes, you can take advantage of certain tax credits and social programs, the calculations for which are directly related to net income for tax purposes (individuals or couples).

You may obtain additional advantages, depending on your situation, from the following programs and credits:

• Quebec child assistance payment and the Canada Child Tax Benefit
• GST and QST credits
• Property tax refund (Quebec)
• Tax credit for child-care expenses (Quebec)
• Amount for a person living alone or with dependent children
• Pension income credit
• Age credit

Reducing your net income could also enable you to minimize your repayment of employment insurance or old-age security pension benefits.

Therefore, if you are unsure about contributing to an RRSP (until March 1 in the following year), you should consider the additional savings aside from those resulting from your tax rate.

Remember, however, that a withdrawal from your RRSP has the opposite effect - it increases your net income.

Should you contribute to your spouse's RRSP?

If you are in a couple, you can choose to contribute to an RRSP on your legal or common-law spouse's behalf. This is one of the applications of "income splitting between spouses". A personwho contributes on behalf of his or her spouse can claim the deduction, thus reducing the couple's income taxes on any withdrawal while ensuring retirement income for both spouses.

To find out whether it is a good idea to contribute to your spouse's RRSP, you need to consider the probable income each of you will have when you withdraw from your RRSP, which normally takes place when you retire. If the spouses anticipate having unequal retirement incomes, both should contribute to the RRSP of the spouse with the lower estimated income.

If one of the spouses has an RRSP and unused contribution rights that he or she expects never to be able use in the future, it is possible to withdraw from his or her own RRSP and contribute to the spouse's RRSPbased on the unused contribution rights of the contributor. This method does not give rise to a tax impact in the current year, but results in income splitting between spouses in anticipation of retirement.

The "Three-Year Rule"

To maximize your planning, you should avoid contributing to the RRSP of your spouse in the year during which he or she withdraws from the plan, or during the two years preceding the withdrawal. If you do contribute during this period, the money withdrawn from the plan will be added to your taxable income up to the amount of the contributions made during these three years.

This "three-year rule" does not apply to mandatory minimum withdrawals from an RRIFcreated from an RRSP to which your spouse has contributed. It is possible to partially bypass this rule by transferring money from your spouse's RRSP to an RRIF and withdrawing only the minimum.

Remember, for the purposes of this "three-year rule", the contribution date is important, not the year of the tax deduction. Therefore, if you wish to contribute to your spouse's RRSP, do so before the end of the calendar year instead of in January or February of the following year. This way, you'll be able to make an unplanned withdrawal, one year earlier, without any negative tax consequences.