Tax Planning Strategies for a High-Income Couple
Meet Ashley and Ryan
There are many high-income earning households across Canada. Some of them may have stepped into high-paying roles early on, while others have had careers that had the potential for high incomes that were not realized until 15 or 20 years or more had passed.
Let’s look at a married couple around age 40 with over $300,000 in annual earned employment income. They have two children. The wife, Ashley, a secondary teacher in the public school system, earns about $80,000 per year. She has benefits and a steady salary. The husband, Ryan, a software developer, started his career at a fairly low salary and without much in the way of employment benefits, but after several years of developing a specialization in cybersecurity, he now earns $220,000 with a history of significant bonuses as well.
Their modest incomes in the earlier years of their marriage have taught them to save well, but they haven’t learned much about investing or the different kinds of accounts available to them. In Ashley’s case, because money was tight and her Teachers’ Pension Plan resulted in a significant Pension Adjustment on her T4 slip, she has never felt much reason to contribute to an RRSP. Now, however, with Ryan’s high income and the realization that they are paying fairly high taxes, they have decided it is time to consider some strategies that will reduce their taxes now and put them in better shape for the future.
Ashley and Ryan’s Tax Situation
Marginal Income Tax Rates
Ashley and Ryan are residents of British Columbia. Given their incomes, $80,000 for Ashley and $220,000 for Ryan, their marginal income tax rates are 28.20% and 46.12%, respectively. This means that on their next 100 dollars earned, Ashley pays $28.20 while Ryan pays $46.12.
Ashley’s taxable income is reduced somewhat thanks to her pension and other pre-tax deductions from work, but Ryan has not had those benefits provided to him as part of his compensation.
Available Tax Strategies
Ashley and Ryan have not been averse to saving over the years. They simply haven’t taken advantage of the opportunities that are available to them. After putting a substantial down payment toward the house they own, they still have over $130,000 in bank savings accounts but are earning very little interest.
Two opportunities that they can take advantage of are Registered Retirement Savings Plans (RRSPs) and Tax-Free Savings Accounts (TFSAs). Ryan has over $210,000 in accumulated contribution room for an RRSP while even Ashley has over $60,000 available. Neither has a TFSA yet so that means an additional $95,000 each could be sheltered from income tax. While Ashley’s pension plan makes contributions to her RRSP less urgent, Ryan would do well to get started considering his income is projected to grow and he has nothing other than his Canada Pension Plan contributions and his non-registered cash savings to rely on for retirement.
Maximizing RRSP and TFSA contributions
Benefits of RRSP Contributions
While Ashley and Ryan have heard about RRSPs, they admit to never having put much thought into them. Some of their friends talked about buying RRSPs as though it was a kind of product. Others talked about taking out loans to buy RRSPs in late February every year. They also got a “pitch” to open RRSP accounts every time they went into the bank and the customer service representative saw the large balance in their savings account. However, they were both wary of accepting sales pitches from anywhere, let alone a major bank.
Recently, however, Ryan learned that their employer had arranged for an advice-only financial planner to come to their office during a “lunch-and-learn” session to talk about saving for retirement, including how to use RRSPs and TFSAs. This seemed like the perfect opportunity for Ryan since he knew he wasn’t going to have a product pushed onto him.
Ryan learned that an RRSP is a government-designed account type that is intended to encourage personal savings for retirement. The encouragement comes in the form of a tax deduction and deferral of taxes on any interest, dividends, or realized capital gains inside the RRSP. This means that investments inside an RRSP have the potential to grow faster since they are not taxed during an account holder’s saving years.
Ryan had often heard about people getting big tax refunds because of their RRSP contributions but he wondered if there was anything he could do to reduce his taxes during the year. He then learned about Form T1213, Request to Reduce Tax Deductions at Source, which he could send to the CRA to process. If approved, his employer would be authorized to reduce the amount of tax remitted to the CRA from his paycheque.
Ryan also heard that, at retirement, it was typical to transfer the assets inside an RRSP into a Registered Retirement Income Fund (RRIF) and begin withdrawing from that account. There was a specified minimum he would have to take out each year, but only the amounts withdrawn would be taxed. The rest of the RRIF account would remain tax-deferred. Even better, from age 65 onward, up to $2,000 taken out of RRIF qualified for a federal tax credit and BC offered a similar credit based on the first $1,000 withdrawn.
Advantages of TFSAs
A week later, the financial planner came back to the office to talk about Tax-Free Savings Accounts (TFSAs). All Ryan knew about TFSAs was that there seemed to be a dispute as to which was better for retirement savings. Somewhat simplistically, Ryan assumed that since the TFSA did not have the word “retirement” in its name it probably wasn’t for retirement.
The financial planner half-confirmed Ryan’s thinking. A TFSA isn’t exclusively for retirement, but it can certainly be used for that purpose if desired. The big difference between the RRSP and the TFSA, Ryan learned, is that contributions to a TFSA do not create a tax deduction. However, like the RRSP, neither interest, dividends, nor realized capital gains are taxed inside the account. And, even if Ryan wants to save his TFSA contributions for retirement, if he needs the money for other reasons, he can withdraw from it at any time without any tax consequences.
Balancing the Contributions
With this newfound information, Ryan and Ashley talked about taking their savings and putting them into RRSPs and TFSAs for each of them. They were a bit puzzled over which account type to prioritize and whether they should put more in the RRSP versus the TFSA. They eventually decided to use half their $130,000 in savings, or $65,000, for RRSP contributions. Since Ashley has a pension plan and Ryan has a much larger income, Ryan would take $50,000 to put into an RRSP in his name. Ashley would use the remaining $15,000 to go into an RRSP.
For the other $65,000, they decided to split it down the middle and put $32,500 into TFSAs in each of their names.
With no experience investing on their own, Ashley and Ryan opened accounts at one of the robo-advisors. They also set up regular contributions into each of their accounts, with Ryan emphasizing his RRSP for the tax advantages offered. Ashley decided to put a bit more emphasis on her TFSA because her lower income and pension plan made RRSP contributions less important and also because she wanted the flexibility of being able to easily withdraw from the TFSA if some unanticipated expenses came along. Eventually, they planned to maximize contributions to both account types.
Additional Tax Planning Opportunities
Registered Education Savings Plan
Ashley and Ryan’s daughter, Sophia is eight years old. Their son, Lucas, is five. The seminars on RRSPs and TFSAs inspired Ryan to start digging a bit more into other account types. They learned about Registered Education Savings Plans (RESPs), accounts that are designed to help families save for their children’s post-secondary education.
They learned that while RESP contributions aren’t tax deductible, they do grow tax-free inside the account. They also learned that any contributions attract a 20% grant from the federal government based on annual contributions of $2,500 per child, or up to $5,000 per child if there were earlier years when contributions were not maximized. Finally, with their tax planning perspective in mind, they were happy to learn that when the money was withdrawn for their education, the portion of the withdrawal that came from grant money and growth of the account would be taxed in their children’s hands, not their own, which given the typical taxable income of students was likely to be a very small amount, if at all.
Ashley and Ryan immediately opened a family RESP for their two children at the same robo-advisor where they held their RRSPs and TFSAs and set up a monthly schedule to contribute $10,000 per year to the account, split evenly between Sophia and Lucas.
Shortly after they opened the RESP at the robo-advisor they learned that British Columbia also offered the BC Training & Education Savings Grant of $1,200 per child. Unfortunately, their robo-advisor did not accept the BC grant, so they opened a new RESP for Sophia at their local bank branch. They plan to do the same next year for Lucas when he turns 6.
Spousal RRSP
When the financial planner talked about RRSPs at Ryan’s company’s “lunch-and-learn,” he also mentioned spousal RRSPs, which are often useful to even out income in retirement between spouses, especially when one spouse intends to retire at a different time than the other. In their case, Ryan, as the higher-income earner, would contribute to an RRSP in Ashley’s name. He would get the tax deduction from the contribution but at retirement, Ashley would be the one who would pay tax on the withdrawals as long as the money withdrawn did not violate the attribution rules.
Given Ashley’s head start with her pension plan, they decided to defer opening a spousal RRSP until Ryan’s RRSP had grown substantially larger and they could see whether it would make sense for them to do that.
Looking Ahead
Ashley and Ryan realize that they have to change their behaviour to reduce their taxes and improve the probability of having a comfortable retirement. All the pieces are right there. Together, the RRSPs and TFSAs, not to mention Ashley’s pension, give them tax-saving opportunities for themselves now and into the future. In addition, the RESP allows them to fund their children’s education in a tax-advantaged way.
Eventually, they will likely generate enough savings to open non-registered accounts where they can take advantage of donating appreciated securities in kind later on in life and possibly purchasing some form of permanent insurance to lessen the impact of taxes on their estate at the end of life.
After ignoring the opportunities to save on taxes for the first many years of their lives together, Ryan and Ashley now see that there are, and will continue to be, plenty of opportunities to be more tax-efficient with their money.
This is the 259th blog post for Russ Writes, first published on 2024-08-26
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