Tax Planning Strategies for Canadians

Meet June and Jack, a Canadian couple in their mid-30s. They’ve been diligent about saving and investing, but as they sat down to review their Notices of Assessment from the Canada Revenue Agency (CRA), they were alarmed by the numbers they saw. Despite their best efforts, they realize that they’re losing a significant portion of their income to taxes each year. They are satisfied with their total income, but by the time they’re done paying taxes, they feel like their after-tax income leaves them with little room to get ahead.

 

June and Jack are not alone. Many Canadians find themselves in a similar situation, overwhelmed by the complexity of the tax system and unsure how to legitimately reduce the taxes they pay. The consequences of making a mistake and inadvertently subjecting themselves to an audit cause them no little fear.

 

What can June, Jack, and other Canadians do to reduce their taxes and help them save more for their current needs and future goals?

 

The Issues

Navigating tax planning can be daunting for average Canadians like June and Jack. Misunderstandings and opportunities not taken abound. And then there are those who think that they are being over-taxed and have the “right” to cheat on their taxes. Missed opportunities mean less money kept for themselves. As for those folks who think that they are clever enough to evade taxes properly owed, such efforts usually backfire and cause much greater financial loss. What are some of the challenges that we would do well to understand?

 

A Lack of Awareness of Tax Credits and Deductions

Many Canadians are unaware of the variety of tax credits and deductions they are eligible for. This can lead to a higher tax bill.

 

Misinterpretation of RRSP Contributions

RRSPs are often misunderstood and viewed as a scam perpetrated on them by the government (I have had these conversations!). Many Canadians who do contribute do so without a long-term plan in mind, failing to maximize their RRSP contribution limit even when the money is available. Worse still, some prematurely withdraw from their RRSPs, effectively reversing the tax deduction, permanently losing their contribution room, and undermining its purpose.

 

Neglecting the Potential of TFSAs

TFSAs are frequently underutilized as a tool for retirement savings. Many Canadians use them for short-term savings instead, missing the potential for tax-free investment income in the long term.

 

Inadequate Planning for Retirement Income Splitting

For couples, inadequate planning for retirement income splitting can lead to a higher combined tax bill in retirement. However, many couples are not aware of strategies like contributing to a spousal RRSP that can help balance retirement income and reduce the overall tax liability.

 

Avoidance of Professional Advice

Lastly, many Canadians avoid seeking professional advice for tax planning. The complexity and ever-changing nature of tax laws can make it easy to overlook potential savings or make mistakes that can lead to penalties.

 

Resolving the Issue

This is not to say that there is no hope for Canadians like June and Jack. The key to navigating the rather complex landscape of taxes can be found in education and strategic planning. By gaining a better understanding of the tax system, using available tax credits and deductions, and making informed decisions about RRSPs and TFSAs, meaningful improvements are within reach.

 

Good Things Canadian Taxpayers Can Do

Digging deeper into tax planning can lead to positive change in a household’s financial landscape.

 

Utilizing Tax Credits and Deductions

Start by educating yourself about the variety of tax credits and deductions for which you are eligible. These can range from medical expenses and charitable donations to tuition fees and, occasionally, employment expenses. By claiming these credits and deductions, you can significantly reduce the taxes you owe. A good source can be found on the remarkably comprehensive and free taxtips.ca.

 

Understanding RRSP Contributions

As noted earlier, despite having been around since 1957, many Canadians need a better understanding of RRSPs. The RRSP is not a scam but a powerful tool for reducing taxable income and saving for retirement. Plan your RRSP contributions strategically, maximizing contributions when you can and when your income warrants it (depending on your province, at taxable incomes above approximately $55,000, prioritizing RRSPs begins to make greater sense). Some people are also unaware of the implications of withdrawals before retirement; for most, unless you are in the lowest income tax bracket, it is probably best to preserve your RRSPs for retirement.

 

Releasing the Potential of TFSAs

Ever since TFSAs launched in 2009, Canadians have thought of this account type as being for short-term savings. While that can be one of its uses, the TFSA is a great tool for long-term investment growth, especially if you are in the lower income range and, frankly, do not benefit from the tax deduction nearly as much as someone in a higher tax bracket. No, you don’t get the up-front tax deduction, but interest, dividends, and capital gains earned in a TFSA are tax-free, as are all withdrawals, making it an excellent tool for retirement savings.

 

Planning for Income Splitting

Canadian couples like June and Jack should explore strategies in their pre-retirement years like contributing to a spousal RRSP. This can help balance retirement income between spouses and potentially reduce the overall tax liability in retirement.

 

Other forms of tax splitting can include a higher-earning spouse providing money to the lower-earning spouse to contribute to a TFSA. Potentially both spouses’ TFSAs can be maximized.

 

If both RRSPs and TFSAs are maximized, then the higher-earning spouse can pay all the household bills which will free up the lower-earning spouse to invest in a non-registered account. Any interest, dividends, or capital gains received will be taxed at the lower-income spouse’s marginal tax rate. Assuming the higher-earning spouse is also investing in a non-registered account, this will mean less of the tax burden falls on the high-income earner, resulting in lower taxation overall.

 

Yet another tax-splitting opportunity is available for those households that have minor children. Regardless of marital status, a parent can contribute to a minor child’s Registered Education Savings Plan (RESP). While there is no tax deduction, the assets in the RESP grow tax-free, attract the Canada Education Savings Grant (CESG) from the government, and all the growth and grant money is taxed in the child’s hands when withdrawn while attending an eligible educational institution. Given that students have access to the usual personal exemptions and the tuition tax credit, as well as the fact that most students do not have a lot of taxable income, it’s quite likely that the money from an RESP can be withdrawn almost entirely without tax consequences.

 

Seeking Professional Advice

Despite the comprehensiveness of many of today’s online tax-filing tools, sometimes there is nothing more valuable than getting tax advice from a licensed professional. This will not only help avoid mistakes but also ensure that all potential tax savings are utilized.

 

Single Individuals

For single individuals without spouses, common-law partners, or children, many of the strategies above still apply. They can maximize their RRSP contributions and utilize TFSAs for long-term investment growth. They can claim employment expenses if they are eligible, take advantage of tax credits that they qualify for, and make charitable donations. They can also be mindful of the types of investments to hold in non-registered accounts to ensure they are taxed efficiently.

 

At retirement or depending on the form of pension income, after age 65, additional tax credits apply, including some to singles, such as the age amount and the pension income amount.

 

The path to effective tax planning is seldom that daunting for the average employed Canadian. With a little knowledge and some thoughtful strategies, we can reduce our tax liabilities and keep more of our money for current needs and future goals.

 

The Positive Consequences

Tax planning can have a significant impact on the financial future of Canadians. By employing strategic tax planning, individuals and families can improve their current financial situation and take meaningful steps toward a more comfortable retirement. Recently, FP Canada, which issues the Qualified Associate Financial Planner™ and Certified Financial Planner^® designations, released their latest edition of the Financial Stress Index. Money continues to be among the top stressors for Canadians. For that reason, planning around taxation as well as other aspects of personal finance can provide peace of mind and confidence. By taking control of one’s taxes today, Canadians can smooth the path toward a more financially secure tomorrow.

 

 

This is the 248th blog post for Russ Writes, first published on 2024-05-27

 

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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, tax, or legal decisions.

 

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