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Spousal RRSP Loophole?

For one reason or another, I’ve been getting emails regarding the same topic, basically discussing a potential spousal RRSP loophole.

What is a spousal RRSP?  It’s almost self explanatory; it’s where one spouse contributes to a separate RRSP account called a spousal RRSP in the name of their spouse.  The advantage is when one spouse makes significantly more than the other.  The higher income spouse can contribute to the lower income spouses RRSP while taking the higher tax deduction and help even out income/taxation during retirement.  More details on how spousal RRSP’s work.

Having explained the basics, what is the loophole in question?  Here is what the reader emailed me:

  • step 1, contribute only to your spousal rrsp every year until you reach a
    target amount $x which would last y years if withdrawing $z (ie basic
    personal amount) every year until your retirement.
  • step 2, for the next 3 years only contribute to your rrsp or tfsa
  • step 3 start taking out from spousal rrsp $z amount and then immediately
    contribute $z to your rrsp. but still contribute what you normally do on
    your rrsp or tfsa. This would effectively split your incomes a little before
    retirement.
  • step 4 at retirement convert your rrsp into rrif and it can now be split
    however you want.

Technically speaking, this process would help reduce taxation as there would be a tax deduction twice on the same contribution, but does it comply with CRA rules?  As I’m not a tax professional, I decided to ping my accountant colleagues/friends to see what they thought.

According to Tax Guy

Now in the specific scenario you provided (the lower income spouse withdraws, gifts to the higher income spouse who contributes to their own RRSP) may run afoul of the General Anti-Avoidance Rules (GAAR). Essentially these rules are as follows:

  1. The series of transactions that involve a tax benefit. In my opinion the benefit is to for the higher income earner to take a tax deduction that they would not have otherwise taken.
  2. The transaction is an avoidance transaction. In other words, the transaction cannot be said to “have been reasonably undertaken or arranged primarily for a bona fide purpose other than to obtain tax benefit.”
  3. Abusiveness. The transaction is not in accordance with the “object, spirit and purpose” of the particular ITA subsection. The purpose of the RRSP deduction is to encourage saving for retirement. The fact that there is the spousal rule attributing income in the two-year period, would appear to make the transaction abusive.

According to Ed Rempel:

The attribution rules don’t apply to RRSPs or TFSAs. Either spouse can contribute to each others plans. They only apply to non-registered investments and income.

To my knowledge, it has never been tested. GAAR is not used often, so I would doubt that CRA would look at that. They would not have a good case for GAAR either, since you could just say that you contributed at the time with the intent to keep it and then needed the money a few years later. They would have to provide evidence that this was an entire pre-planned scheme.

It seems that there are mixed reviews about the strategy, so tread at your own risk.  For you tax pros out there, what are your thoughts?

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FT About the author: FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.

{ 19 comments… add one }
  • Michael James February 10, 2010, 10:40 am

    The downside of this scheme is that it burns some RRSP room. Depending on whether you’re able to save the full amount of your RRSP room and how long it would stay in the RRSP, you may actually be better off not using this scheme. However, done properly and assuming it is legal, many couples would probably benefit from this idea.

  • Four Pillars February 10, 2010, 12:04 pm

    I’m not sure how this qualifies as a “loophole” – I’d call it a good strategy.

    It’s basically just having the lower income spouse withdraw from the rrsp at a lower marginal rate. I don’t see why the CRA would have any problem with this. The money was contributed into the spousal rrsp, it stayed there for the minimum 3 years and then it was withdrawn. At that point you can do whatever you want with it.

    This is the same strategy as someone who has variable income contributing more to the rrsp in the good years and then doing some withdrawals in the “bad years”.

  • cannon_fodder February 10, 2010, 12:44 pm

    Another aspect of contributing so much to a spousal RRSP is that the contributor gives up the contribution room. As a person who did that extensively before his 1st marriage fell apart, I know how much I wished to get that contribution back.

    My ex, on the other hand, had a large amount of contribution room left. There is no way to get that contribution back unfortunately.

    As for this strategy, I would think it definitely could work if your spouse retired and withdrew from her RRSP while you were still employed. But, I don’t see that type of circumstance occuring in my situation.

  • Fred February 10, 2010, 1:07 pm

    I do not see the double deduction angle here. If you withdraw from the spousal you do not get the room back so unless you are contributing $z less than the maximum you could contribute, there is no extra deduction and you have lessened the amount of money in your RRSP. If you are maxing out your contribution every year, this is just a way to get some dollars out of your RRSP tax free.

  • Nelson February 10, 2010, 1:42 pm

    Why do we need “strategies” to invest?

    Why can’t it just be simple?

  • Ben February 10, 2010, 1:46 pm

    According to the letter of the Income Tax Act as far as RRSP’s are concerned, it should technically work. There is a benefit resulting from a second RRSP contribution.

    However, I would be much more wary of GAAR applying. Although it hasn’t been used much in the past by CRA, it is definitely becoming much more prevalent. GAAR’s application has already been successful in a number of cases, including at least one at the Supreme Court level (decided in favour of CRA).

    Historically, RRSP’s are definitely one of the major areas that CRA has actively applied GAAR. With the recent concerns about TFSA overcontribution abuses, I would not be surprised to see CRA aggressively going after taxpayers trying to take advantage of RRSP and TFSA rules.

  • The Reverend February 10, 2010, 2:53 pm

    I know several people that have used this strategy when their spouse decided to stay at home when they had kids.

    At that point, they didn’t have a lot of extra dollars to be contributing to RRSPs at all, so they withdrew from spousal and put right back into the working parents RRSP and got a tax deduction.

    Absolutely agree this is doesnt’ work if you max out RRSP contributions.

  • Brendan February 10, 2010, 3:47 pm

    Cannon, I too did the spousal RSP and lost my contribution room. But it saved my DB pension as the commuted value was equal to my half of the spousal. I am glad i did spousal RSP’s.

    I cant see how this is a “loophole”. They are the rules. Dump cash into a spousal, wait 3 years and its hers to do as she pleases, be it quit work and raise a family, go back to school.
    If CRA attacked this then what next? Will they go after your RSP if you retire before 65 because you are really “supposed” to work until that age.
    WHat about the RSP meltdown? I think GAAR is very scary. If they were to use GAAR they could pretty much question anything a taxpayer does if they thought it was questionable.
    CRA already has lots of rules stacked in their favour (have to declare capital gains when putting into an RSP but you cant claim losses) so they should just stay the hell out of everyone’s life.
    Maybe we should all quit working and sit on welfare, and then see how CRA likes it.

  • Brendan February 10, 2010, 3:49 pm

    Ben, how has CRA actively applied GARR to RSP’s? RSP’s are straight forward.

  • andrewbpaterson February 10, 2010, 3:52 pm

    Ed Rempel, “They would have to provide evidence that this was an entire pre-planned scheme.”

    Isn’t that exactly what it is??? An entire pre-planned scheme?

    I would avoid an investment scheme that would require me to *trick* the CRA.

  • Mike February 10, 2010, 4:55 pm

    Ed Rempel, “They would have to provide evidence that this was an entire pre-planned scheme.”

    The point Ed is making is not that it isn’t a scheme but that the onus is on CRA to provide evidence that it was pre-planned. That is not going to be easy.

  • Fred February 10, 2010, 4:59 pm

    Deposit, wait 3 years, withdraw and redeposit might be tough to prove it was pre-planned. Do this more than once and there is a pattern that will be hard to prove it was not.

  • ethan February 10, 2010, 6:25 pm

    Hi,
    I am one of the readers that emailed regarding this strategy. Actually to avoid this GAAR thingy for step 3, the $z amount that my spouse took out from her rrsp need not be put back into my rrsp but it can be used to pay for various expenses normally taken from my income like groceries, mortgage etc. which would help me save money to put into rrsp and tfsa.

  • Fred February 10, 2010, 6:44 pm

    Ethan…is it safe to assume you do not max out your rrsp every year?

  • Commander T February 11, 2010, 1:35 am

    I really doubt that the GAAR would apply to this transaction. The reason why it would not fall under the GAAR is because it is not an abuse of the act. The entire purpose of the spousal RRSP rules is to allow a limited way to split income with the spouse (if the government did not want it to be possible to split income with the spouse using RRSPs there would be absolutely no need for the spousal RRSP rules).

    I just thought of a major flaw to this strategy. The strategy ignores the fact that the working spouse will get the spousal credit which will be reduced dollar for dollar by the say at home spouse’s income above 500 or so. the only advantage to this strategy would be the tax rate differential between the low tax rate and whatever tax rate the working spouse is at.

    To put dollars to this issue. Spouse A who has employment income of 80,000 and spouse B who has income of 0 both resident in Ontario. Spouse A will pay tax of 19,984. If spouse B withdraws 10320 (the federal basic personal tax credit) out of a spousal RRSP and spouse A contributes 10320 to an RRSP, then A will pay taxes of 18,374. Therefore there is only a savings of 15.6% which is approximately equal to the difference in marginal tax rate between the lowest rate and the 80,000 marginal tax rate. (These numbers are from the calculator at taxtips.ca)

    Overall this generally should be a valid way to split income.

  • Ed Rempel February 11, 2010, 2:33 am

    Hi Ethan,

    I would not worry about this strategy if you do it once. It is relatively common to take some money out of a spousal RRSP when you have a low year. GAAR might become a factor if you did it repeatedly every 4 years.

    I wouldn’t really call this a loophole. The benefit is really not that large. Remember, in the year your spouse withdraws, you would otherwise be able to claim her as a dependent. In essence, you will either pay tax or lose tax savings of 21% on the amount of the withdrawal, so it is still in essence taxed at 21%.

    Your rate could be the top rate (say 46%), but that means you save 25% once every 4 years. You can’t do this with a very large amount, because your spouse would get into the higher tax brackets when you withdraw.

    A better strategy could be to just keep building up the spousal RRSP until 10 years or so before retirement. Then wait 3 years and start withdrawing an amount every year.

    GAAR would not apply because you are funding an early retirement.

    The problem with these strategies is that there is a tendency to miss the real benefit just to save a little tax. The tax-free compounding from leaving your investments in your RRSP for many years can be a much bigger benefit than just a little tax saved.

    It is more effective to create your entire retirement/investment/tax plan to create the retirement that you want and then see if some tax strategy like this might fit into it. Focusing on saving a few bucks on a tax strategy can take you away from your real plan that should have much larger benefits.

    Ed

  • Max February 12, 2010, 1:13 pm

    Generally, if your spouse is not working, then you can use their basic personal amount on your taxes. If they’re now withdrawing their basic personal amount, you’re not getting it anymore. It’s a wash.

    For example, without this, you get an effective basic personal amount of about $18k. Now when s/he withdraws, s/he uses up the $9k, and you only have $9k. Therefore, you’re giving up $9k in basic personal amount to gain… $9k tax free contribution. And also burning up contribution room.

  • Stephen April 4, 2010, 8:13 pm

    The real advantage is to move 25K of income to the lower-earning spouse. If A makes 80K, and B makes 10K, then B contributes 75K to the lower-earning spouse (if possible), and Spouse B withdraws 25K per year for 3 years. Effective tax rate for this 75K block has gone from 40% to 20%, = 15K of tax savings. Thats not a minor amount. Of course, your contribution room will suffer, but…

    Allowing your savings to grow tax-free is ok, but not the be-all of investing. Don’t forget that RRSP’s tax capital gains at 2x the rate of non-registered investments, because its taxed at income rates, not Capital Gains. Depending on your investment strategy, and plans for the income, it might be better to keep your money elsewhere.

  • bluenosed October 18, 2010, 10:08 pm

    Has everyone ignored the obvious risk here of more than 50% of marriages ending in divorce? Spousal RRSP no thanks.

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