Splitting income between family members can reduce taxes payable by the entire family, especially if members are in different tax brackets. Tax legislation, however, limits this opportunity through attribution rules that result in income, and in some cases, capital gains, being taxed to the individual primarily responsible for the income.
One such rule is the spousal RRSP attribution rule, found in section 146(8.3) of the Income Tax Act. The rule states that when the annuitant of a spousal RRSP makes a withdrawal from the plan, all or part of the withdrawal would be taxed to the contributing spouse, not the annuitant. Specifically, contributions made in the year of the withdrawal or the previous two calendar years would be taxed to the contributing spouse.
A similar rule applies to RRIF income for amounts in excess of the RRIF minimum for the year. The attribution rule ceases to apply when a spousal or common-law partnership breaks down, on death of a contributing taxpayer and when either spouse becomes a non-resident of Canada.
The attribution rule is in place to prevent the short-term use of spousal RRSPs for income-splitting purposes. Where withdrawals exceed amounts contributed within the spousal attribution period, income splitting is achieved.
Consider the following example.
For each of the past ten years, Troy has contributed $15,000 to Marie’s spousal RRSP, maximizing his RRSP contribution room each year. His most recent contribution was in February 2016 which, for tax purposes, he deducted against his prior year’s income. Later in 2016, Marie needed cash to fund an unexpected emergency, so she withdrew $50,000 from her spousal RRSP. Because Troy had contributed to the spousal plan in the current and previous two-year period, Marie’s withdrawal triggered the attribution rule, resulting in $45,000 being taxed to Troy ($15,000 for each of 2016, 2015 and 2014). The remaining $5,000 was taxed to Marie.
The above attribution rule is fairly straightforward when the situation involves only a spousal RRSP. How would the rule apply, if at all, if Marie was the annuitant of both a spousal and non-spousal RRSP and her $50,000 withdrawal was from the non-spousal plan? Would the spousal attribution rule apply given that Troy contributed to her spousal RRSP in the current and previous two-year period?
The CRA commented on this situation in a technical interpretation bulletin in 2012 (2012-0462061E5). In the bulletin, the CRA confirmed that, as currently worded in section 146(8.3), the spousal attribution rule only applies to situations where the amounts withdrawn are from a spousal RRSP. Where amounts are withdrawn from an RRSP to which only the annuitant contributed (i.e., a non-spousal plan), the withdrawal(s) would be taxed to the annuitant and not the spouse. This would be the case regardless of contributions made to the annuitant’s spousal RRSP in the current or previous two-year period.
So, if Marie’s withdrawal was from a non-spousal RRSP, no portion of the $50,000 would be taxed to Troy; the full amount would be taxed in Marie’s hands. For this reason (among others), many annuitants have both spousal and non-spousal RRSPs. Having both plans provides greater flexibility when it comes to RRSP withdrawals.
Given the above spousal RRSP attribution rule, and also considering tax brackets and the availability of RRSP contribution room, some clients avoid contributions to spousal plans, choosing instead to gift money to their spouse for the spouse to contribute to his or her own non-spousal RRSP.
Consider the following.
Laurie, a high-income earner, maximized her RRSP contribution room for the year. Her spouse, Cecil, a lower-income earner, has room still available. To take advantage of Cecil’s contribution room, Laurie gifts $10,000 to Cecil, which Cecil promptly contributes to his non-spousal RRSP. Two years later, Cecil withdraws the full $10,000. Who is taxed on the withdrawal: Cecil or Laurie?
The 146(8.3) attribution rule for spousal RRSPs does not apply in this case as we are not dealing with a spousal plan. But, this does not mean that the couple can freely gift assets to each other without consideration of attribution rules. Section 74.1 of the ITA states that where assets are gifted from one spouse to another, any income earned from the gift is taxed to the gifting spouse. This rule generally applies to gifts regardless of type, and as per CRA technical interpretation 2003-0044021E5, it appears that the rule extends to non-spousal RRSP income. So, in the absence of fair market value consideration received from Cecil in exchange for Laurie’s gift, it appears that the 74.1 attribution rule can apply to Cecil’s $10,000 RRSP withdrawal, resulting in taxation of the income to Laurie at her higher tax rate.
RRSPs are valuable retirement savings tools, primarily because of their effectiveness in deferring taxable income. Spousal RRSPs provide the additional benefit of income-splitting, subject to the three-year attribution period. Understanding the attribution rules as they relate to RRSPs and RRIFs can allow Canadians to make the best use of these plans.