Who gets what? When a marriage breaks, a couple's major assets are divided as well. But when they are socked away in registered plans, splitting those assets evenly and smartly becomes about avoiding tax hits.
Registered retirement savings plans (RRSPs) and registered retirement income funds (RRIFs) as well as pensions are considered family property to be divided 50-50 in a legal separation or divorce. The Income Tax Act provides for tax-free rollovers of RRSPs and RRIFs between spouses where there is a court order or written separation agreement, which allows for the equalization of registered assets without significant tax implications.
But then things get tricky. Dividing the funds in registered plans along with other family assets can involve complex deliberations and leave one or both members of the couple scrambling to make up for retirement.
"For most people the math doesn't work very easily," says Eva Sachs, a certified financial planner in Toronto who is also a certified divorce financial analyst specializing in issues such as financial settlement options for divorcing couples.
More than half of the clients Ms. Sachs sees in her fee-for-service consultancy, called Women in Divorce Financial, are ending marriages of between 20 and 30 years. Already in their late 40s or early 50s, these couples must quickly gear up for retirement, while variously paying hefty costs related to the separation, learning anew to manage finances and supporting two households.
"Getting divorced really messes up the retirement plans they had been working on as a couple," she says. "It's a huge thing."
Take Peter and Joan Wright, for example. The Wrights (not their real name) jointly own a house worth $500,000 and RRSP assets worth $400,000. Mrs. Wright wants to keep the house, which means she must give cash - or the equivalent in RRSPs - to her ex. (She could perhaps take out a significant line of credit or extend the mortgage on the house to pay him some of the funds.) Mr. Wright may end up with the lion's share of the RRSPs, but he then needs to pay for housing and other costs.
One significant issue on the divorce ledger sheet is that the value of RRSPs is calculated by taking into account the deferred tax that must be paid. A notional tax rate is usually applied, based on the expected income and thus the taxation level upon retirement of the person who gets them.
"Sometimes the negotiations get a little complicated," says Douglas Lamb, a certified financial planner at Spera Financial in Toronto.
The best way to get back on track with RRSPs, he says, is to establish a comprehensive financial plan "that reflects an individual's new economic realities" and develop an investment plan that supports it. That means figuring out any new expenses and sources of income as well as projecting what you will need for retirement.
A spouse who is newly receiving regular alimony or child support payments, for example, must realize that this is income that is taxable, but also handily creates RRSP room, Ms. Sachs says. Making sure to set aside the funds to pay the tax or to invest in the RRSP, while covering all other expenses incurred in their new household, is critical.
Many people end up with huge costs related to the divorce itself, she explains, such as legal bills, counselling for the kids and credit card debt from emotional spending. Many people finance these expenses by cashing in RRSPs. Worse, she says, many people take a hiatus from making RRSP payments, thinking they will get back to it, but "it's hard to start up again."
Getting good advice, establishing a firm financial plan and making informed decisions on your retirement, she says, must start with figuring out what your new life is costing and buckling down on expenses.
"Something has to give," Ms. Sachs says. "You need to adjust your spending to meet the new reality."
Mr. Lamb adds that often in the case of divorce, one partner is less aware of issues such as RRSPs, especially if the other partner had the "financial administration responsibilities, wrote the cheques and did the investing."
Those in the first category "have all of the emotional turmoil of the separation and they're just bewildered," he adds. In such cases, doing a long-term plan and considering where funds will come from in retirement, be it from RRSPs, tax-free savings accounts or even a real estate investment, he says, will "tell you what you're going to do for the rest of your life."
Spousal RRSPs Investing in a spousal RRSP is a smart move for couples who want to split their income - and pay less combined tax - in retirement. If you break up before you get to that stage, however, the assets belong to the person whose name is on the plan, although the funds will be equally divided.
Spousal RRSPs are especially useful when couples anticipate that they'll generate unequal amounts of taxable income when they retire, for example from pensions, retirement savings or investments. They can also be used to build up both spouses' RRSP accounts in equal proportion, where one person doesn't work or earns less and therefore has less RRSP contribution room than the other.
In a spousal RRSP, one spouse uses his or her own contribution room to pay into an RRSP account in the partner's name. The person who makes the investment benefits from the tax deduction, while the partner in whose name the RRSP is registered owns the account.
Upon divorce, spousal RRSPs are actually treated the same as the rest of the family's assets. A couple's RRSPs and RRIFs are evenly split and can be transferred tax free, so in most instances contributing to a spousal RRSP is no different from contributing to an RRSP in your own name.