Giving the Government its Due: Taxation
An Introduction to Tax Planning – Part 1
Financial Planning and Taxation
As much as we might like to deny it, taxation is an integral part of financial planning. Indeed, taxation can often be a Canadian household’s biggest single expense. Think about all the areas in life in which tax considerations are significant:
- When you spend money to buy groceries, you are paying for those groceries with your take home pay, after tax has been deducted.
- Some of the items you buy at the supermarket have a sales tax applicable to them.
- When you save money in a bank savings account, the interest you earn is taxable.
- If you have put some money into a non-registered investment account, depending on the investment, you may pay regular rates of tax, or you may get a dividend tax credit, or you may be able to defer tax until it is sold.
- If you invest that money inside a Tax-Free Savings Account, you contribute with “after-tax” dollars, but there is no taxation on the income, dividends, capital gains or withdrawals from the account.
- If you put that same money into an RRSP, the contribution is “before-tax” and there is no taxation on income, dividends or capital gains, but you do pay tax on the withdrawals.
- If you have a US-domiciled investment, like Microsoft stock, for example, depending on the account in which those shares are held, you may have no US withholding tax on the dividends, you may be taxed but can claim it on your tax return as a foreign tax credit, or you may have to pay the tax without any recourse.
- If you have group disability insurance coverage through your employer and you pay the premiums, the disability payments are tax-free; if your employer pays the premiums for you, the disability payments are taxable.
These instances above show that taxation has implications and opportunities across a wide variety of areas. As a financial planner, I am a generalist regarding a broad range of financial matters. I am not an accountant who specializes in taxation. However, I can introduce the topic and give guidance on areas where you may be able to take appropriate advantage of Canada’s tax laws to eliminate, reduce or defer your taxes.
The simplest way to eliminate taxes is to reduce your income. That is probably not what most people are looking for, however. There are certain methods of arranging your financial affairs so that at least certain parts of your income are not subject to taxation. The Tax-Free Savings Account is a great example of this. Another is the purchase of a primary residence. While almost all other non-registered property is subject to capital gains tax when it is sold for a gain, the sale of your primary residence is not.
Sometimes we cannot eliminate taxes altogether, but there may be opportunities to reduce taxes by splitting income. A retired couple can split their pension income in order to even out the income reported on their respective tax returns. This is especially valuable when there is a meaningful difference between the income of one spouse versus the other. For example, in 2019, the federal tax bracket for someone earning taxable income of $47,630 or less is 15% and 20.5% if you are earning more (up to $95,259). If two spouses, with taxable income of $60,000 and $30,000, respectively, can split their taxable incomes so as to reduce them to $45,000 each, then they are both in the lower tax bracket resulting in tax savings.
As the saying goes, the only things that are certain are death and taxes. You may not be able to eliminate taxes altogether but there are ways to defer paying the inevitable to a later date. In this regard, I think of investments in general and RRSPs in particular. Many people see the RRSP as a great way to get a tax deduction. But when they are retired and have to convert their RRSPs into a source of income via RRIF or annuity, they resent the taxes that are applied on those withdrawals. Still, that deferral gave the investments inside of the account years to grow without tax applying, which greatly expands the ability of that account to sustain you in retirement.
In the next several posts in this series on tax planning, I will be writing about various means to minimize taxes, and maybe even one or two methods that you should seriously consider avoiding. Happy tax season!
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Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, accounting or legal decisions.