By Sara Gillett
We may spend most of our working lives saving for retirement and contributing to a Registered Retirement Savings Plan (RRSP) in preparation for our senior years, but what happens to your RRSP if you and your spouse divorce?
Unless your RRSP falls under one of the exceptions set out in the Matrimonial Property Act, it is considered “matrimonial property” and is subject to division during a divorce.
RRSP withdrawals are taxable income, accordingly funds should not be withdrawn to effect division due to the tax consequences resulting from RRSP withdrawals. It is also important to consider tax consequences when selecting a method for dividing RRSPs with a spouse in a divorce.
When dividing RRSP assets upon divorce there are two options; roll over or asset trade off.
Option #1 – Roll Over
In a divorce you’re allowed to roll over RRSP funds tax free to a spouse by transferring RRSP funds to another RRSP held by your spouse. This makes for a very simple and convenient method for division in many cases, and Canada Revenue Agency (CRA) permits it regardless of available contribution room.
Rolled over funds will not be taxed at the time of the transfer, as it is not treated as a withdrawal by CRA. However, the recipient spouse would pay taxes on any future RRSP withdrawals made afterwards.
This option may not be preferrable if the spouse receiving the division needs an influx of cash in the foreseeable future following a divorce because they will not be able to withdraw and access these funds without incurring tax consequences. If you withdraw funds early from an RRSP you pay a withholding tax on the withdrawal, plus you pay income tax as any withdrawals are added to your income when filing your annual tax return.
Option #2- Asset Trade Off
This option is preferable when the spouses each wish to retain their RRSPs, or if a spouse needs cash in the foreseeable future and they do not want to be faced with the prospect of the tax consequences discussed above.
However, when using this method, it is necessary to account for the tax reduction when dividing the value of the RRSP. An RRSP is a pre-tax asset so it will be reduced for tax when it is divided, by the marginal tax rate of the RRSP holder in retirement.
For example, John has an RRSP worth $100,000 and has a personal marginal tax rate of 29.95%. John wishes to retain his RRSP but needs to divide it equally with his former spouse. John agrees to divide his RRSP after it is reduced for tax. Mary also prefers this option as she needs funds immediately.
$100,000 x .2995 (29.95%) = $29,950
$100,000 - $29,950 = $70,050 reduced for tax
$70,050 / 2 = $35,025
The result is John will retain his RRSP and pay Mary $35,035 in cash or an asset of the equivalent value.
Since RRSP withdrawals are taxable for the spouse who retains them, it would not be fair to use the gross or pre-tax values when using this division method, and for this reason, the reduced-for tax-value is accounted for in the division.
This article is for information only and is not intended to be legal advice. If you have any questions or would like further information, you should consult a lawyer.
