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Fears of split hold back spousal RRSPs

Many couples are reluctant to take advantage, despite plan's benefits

Special to The Globe and Mail

Every year for about a decade, Nirmala MacKenzie contributed to her husband's registered retirement savings plan.

Though both were high income earners, with an age difference of 10 years, her husband had fewer working years left before retirement.

So "I got the tax writeoff and he was able to build up his retirement income," says Ms. MacKenzie, a financial controller for a medical products distribution company near Toronto.

During her marriage, she was a firm believer in spousal RRSPs. Although she and her husband separated two years ago, she still is.

"Would I do it again? Probably. The spousal RRSP is still a great vehicle for income-splitting," Ms. MacKenzie says.

Despite the benefits of spousal RRSPs, many couples are reluctant to take advantage of them, say financial advisers -- and the prospect of marriage breakdown is one of the main reasons.

"It's not very popular because, if the couple splits up, the money belongs to the spouse who holds the RRSP, not the one who contributed the money. A lot of my clients don't like that idea," says Daniel Adelstein, a chartered accountant and certified financial planner in Toronto.

Those who are more interested tend to be boomers within a decade of retirement, says Murray Morton, branch manager and a certified financial planner in Toronto with Cartier Partners Financial Services Inc., part of Dundee Wealth Management Inc., who are committed to their marriages, have a clear picture of how much each will have when they stop working and become very focused on retirement planning.

Generally, though, spousal RRSPs aren't being widely embraced, says Warren Baldwin, regional vice-president at T.E. Financial Consultants Ltd. in Toronto.

Although married and common-law couples are eligible, including same-sex couples since 2001, many just aren't informed about them, Mr. Baldwin says.

Too many people typically scramble at the last moment to buy an RRSP and there isn't time to understand the income-splitting advantages that a spousal RRSP offers, Mr. Baldwin says.

"There is a gulf of understanding about spousal RRSPs. You have to think outside the box to see that it can be to your long-term advantage if you set it up right," he adds.

A spousal RRSP makes sense, Mr. Baldwin says, when one partner clearly has a greater income and/or more assets.

The higher-income spouse can make a contribution to the partner's RRSP, which will be deducted from the contributor's contribution room.

The contributing partner gets the tax deduction and, by building up the other's RRSP, lessens the couple's overall tax bite at retirement. When money is withdrawn from the spousal RRSP down the road, it's taxed at the owner's rate, not the contributor's.

If the higher-income spouse put the money into his or her own RRSP or other investments, his or her retirement income could be so high that Old Age Security benefits could be clawed back, Mr. Baldwin says.

So overall, by shifting the money to the other spouse's hands, Mr. Baldwin says, the couple can equalize their retirement incomes, pay less tax altogether and not lose out on Old Age Security.

There is another benefit. After age 69, you can no longer contribute to your own RRSP but you can contribute to your partner's registered plan, as long as he or she is younger than 69 and has the contribution room.

The catch is that the contributing spouse must still be working. The funds for the spousal RRSP can't come from any other source, says Dawna LaBonte, spokesperson for the Canada Customs and Revenue Agency in Ottawa.

Still, there are a couple of caveats to keep in mind.

For one, spousal RRSPs don't make sense if the parties' incomes will be similar in retirement, says Mr. Baldwin.

"It's not worth talking about if they're at the same income level or one spouse has a really good pension but the other has significant RRSP assets of their own, or will inherit," Mr. Baldwin says.

Then there's the restriction of the three-year rule.

Federal tax laws state that if the spouse who owns the spousal RRSP taps into the money within three years of when the contribution is made, the contributor gets taxed, at his or her own rate.

"Clearly, a spousal RRSP doesn't work in a case where the one who owns it is a terrible spendthrift," says Mr. Baldwin.

The three-year restriction can also become an issue when couples split, says Mr. Morton.

"The spouse could be strapped for cash or just want to be vindictive, to stick the ex with a big tax bill. One client called up wanting to know if his estranged wife had taken the money out," Mr. Morton says.

Privacy laws prohibit divulging any information about assets held by an estranged partner, adds Mr. Morton.

In fact, there's more protection for the contributor in such a case than many people realize.

Once a couple is living separate and apart, even without a separation agreement, the contributing spouse is no longer liable to pay the tax on any funds removed from a spousal RRSP, says Ms. LaBonte. The one who owns the RRSP has to pay up.

For many disaffected former spouses, it's hard to accept that they aren't entitled to the money they contributed to a spousal RRSP, says Sarah Boulby, a family lawyer with McCarthy Tetrault LLP in Toronto.

"Sometimes people find that difficult to understand, that it's the other spouse who owns the RRSP. They think of the money as theirs," says Ms. Boulby.

If the separating parties choose, RRSP holdings from one can be rolled over to the other without any immediate tax payout. The one on the receiving end pays tax on the money later, when it's withdrawn, Ms. Boulby says.

In Ms. MacKenzie's case, her husband now owns a bigger RRSP portfolio than she does.

Whether some of it should be transferred to her RRSP or whether she should take more of the proceeds from the sale of the house is one of the issues to be decided in her separation agreement.

"It gets complicated with RRSPs because you have to adjust for the taxes, you just can't take it dollar for dollar," says Ms. MacKenzie.

Trying to figure it all out can get so rancorous that "sometimes people say, 'Let's just split the RRSP dollars equally' to avoid arguing over what the tax allowance should be," Ms. Boulby says.

As complicated as separation settlements can be, not investing in a spousal RRSP won't simplify matters, says Mr. Baldwin.

They're just one more asset that goes into the overall mix to be divvied up, Mr. Baldwin says.

In fact, not putting money into your spouse's registered retirement fund can be the bigger risk, Mr. Baldwin says.

"That's a decision that comes at a big cost," Mr. Baldwin says.

Your marriage may or may not last but one thing is for sure, Mr. Baldwin says -- the more you keep in your own name, the bigger the tax wallop when you retire.

© The Globe and Mail

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