Knowing how tax rules affect your investments is essential to maximizing your after-tax return. In addition, keeping up to date on changes to the tax rules ensures that you take advantage of all the tax savings available to Canadian-resident individuals. This article provides an overview of select strategies to assist you in reducing your tax bill.
Reduce tax with income-splitting
Under our tax system, the more you earn, the more you pay in income taxes on incremental dollars earned. With this in mind, it makes sense to spread income among family members who are taxed at lower marginal rates in order to lower your family’s overall tax burden, subject to the income attribution rules. Some of the more common income-splitting strategies you may want to discuss with your tax advisor include: • Pension income-splitting between spouses (or common-law partners); • Gifts to adult children or other adult family members (other than a spouse or common-law partner); and • Gifts to a minor child – directly or through a trust structure – to acquire investments that generate only capital gains.
Make your portfolio tax-efficient
In evaluating investments for your portfolio, you should consider the impact of income taxes, since not all investment income is taxed in the same manner. Despite the wide range of investments available, there are three basic types of investment income: Interest, Capital Gains and Dividends. Interest income is fully taxable at your marginal tax rate, whereas you only pay tax on 50% of a Capital Gain. Canadian Dividends also receive special tax treatment through the Federal and provincial dividend gross-up and tax credit mechanisms.
Maximize your tax deferred savings with an RRSP, TFSA, or tax-free First Home Savings Account (“FHSA”)
Your Registered Retirement Savings Plan (“RRSP”) is likely the cornerstone of your overall retirement strategy. Allowable contributions to your RRSP are tax deductible and the income earned in an RRSP is not taxed until it is withdrawn. This means that your savings will grow faster in an RRSP than they would if held outside an RRSP. Some ideas to optimize your RRSP savings include maximizing your annual contribution limit, contributing securities “in-kind,” deferring the maturity of your RRSP until age 71, and contributing to a Spousal RRSP if you and your spouse/common-law partner will have disproportionate retirement income levels.
The Tax-Free Savings Account (“TFSA”), introduced in 2009, is a general purpose, tax-efficient savings vehicle that allows individuals, 18 years of age or older, to contribute annually (now $7,000) to this registered account, where both income earned within the plan and withdrawals are tax-free. A TFSA is beneficial for many investors and for many different reasons, including saving for short-term purchases, such as an automobile, or saving for longer-term goals such as a child’s education or retirement. TFSAs can also be an effective income-splitting tool. A higher income spouse can give funds to the lower income spouse or an adult child so that they can contribute to their own TFSA (subject to their personal TFSA contribution limits), since the attribution rules will not apply to income earned within the spouse’s (or adult child’s) TFSA. Because of its flexibility, a TFSA complements other existing registered savings plans for retirement and education. As a result, the TFSA has quickly become an important investment vehicle for many Canadians.
Introduced in 2023, the tax-free First Home Savings Account (“FHSA”) is a new registered savings account allowing first-time home buyers to save up to $40,000 towards the purchase of their first home. Combining hallmark attributes of RRSPs and TFSAs, contributions made into the FHSA are tax-deductible and income earned in an FHSA is not subject to tax. Qualifying withdrawals (including investment income) from the FHSA, to purchase a first home, will be non-taxable. First-time homeowners, who are at least 18 years of age or older, are eligible to open an FHSA, subject to an annual contribution limit of $8,000, with a lifetime limit of $40,000. However, unlike an RRSP, contributions to an FHSA must be made before the end of the calendar year to provide a current year deduction; eligible first-time home buyers should therefore consider opening an FHSA and making a contribution before the end of the year.
Use an RESP to save for children’s education needs
The increasing cost of post-secondary education is causing many parents to be concerned about funding their child’s education. The benefits of the Canada Education Savings Grant (“CESG”), combined with the advantages of an Registered Education Savings Plan (“RESP”), make RESPs a very attractive vehicle to fund your children’s or grandchildren’s education. Contributions to an RESP are not tax deductible. However, the income from investments in an RESP is tax sheltered as long as it remains in the plan. Withdrawals to pay education expenses from accumulated income and the CESG will be taxable in the beneficiary’s hands at his/her marginal tax rate.
Use an RDSP to save for the financial needs of a disabled child
The Registered Disability Savings Plan (“RSDP”) is a registered savings plan intended to help parents and others save for the long-term financial security of persons with severe or prolonged disabilities who are eligible for the Disability Tax Credit. Contributions, up to a lifetime maximum of $200,000 per beneficiary, can be made to an RDSP until the end of the year in which the disabled beneficiary turns 59, with no annual limit. Contributions are not tax deductible; however, any investment earnings that accrue within the plan grow on a tax deferred basis. In addition, Canada Disability Savings Bonds (“CDSB”) and Canada Disability Savings Grants (“CDSG”), up to annual and lifetime limits, can be received in an RDSP from the Federal government depending on family income.
Donate appreciated securities
The benefits of making a charitable donation are countless, from helping those in need to the personal satisfaction we feel when giving something back to a cause we feel passionate about. With proper planning, you can also reduce your income tax liability and maximize the value of your donation. A donation of publicly-traded securities may be preferred over a cash donation of equal value, particularly in cases where you have already decided to dispose of the securities during the year. A charitable tax receipt equal to the fair market value of securities donated to charity will reduce your taxes through a donation tax credit. Donations over $200 made from income subject to the top Federal marginal rate can result in tax savings. A donation of securities is considered a disposition for tax purposes. However, because of the tax incentives on a donation of qualifying, appreciated publicly-traded securities to charity, the capital gain inclusion rate is nil instead of the normal tax that would otherwise apply. Use borrowed funds to invest
Generally, interest expenses are deductible for tax purposes if the funds are borrowed for the purpose of earning income from a business or an investment vehicle. Therefore, consider paying down non-deductible personal debts (such as RRSP loans, mortgages on home purchases and credit card balances) before paying down tax-deductible, investment-related debt. For more information, ask your BMO financial professional for a copy of our publication, Leveraged Investment Strategies and Interest Deductibility, and speak with your tax advisor about structuring your borrowing to achieve tax deductibility.
Reduce tax for your estate
Your estate plan can accommodate a number of tax saving strategies which may help to reduce or defer the amount of tax payable by your estate and help maximize the amount available to your heirs. Use a trust to split investment income. If your beneficiaries are likely to invest their inheritance, it may be possible to protect your assets and reduce tax on investment income by using trusts created in your Will – called “testamentary” trusts. Similar to trusts created during your lifetime (“inter-vivos” trusts), any income retained in a testamentary trust will be taxed at the top marginal tax rates.
Name a beneficiary for your RRSP, RRIF or TFSA
The value of an RRSP or RRIF is included in the tax return of the annuitant in the year of death. If the beneficiary is your surviving spouse or a financially dependent child or grandchild, your estate will generally not be taxable on the proceeds from the plan. Instead, the beneficiary will include the proceeds in their income. Your surviving spouse can defer the tax on the proceeds if the funds are rolled into your spouse’s own RRSP or RRIF. Taxes can also be deferred if the beneficiary is a financially dependent child or grandchild who is a minor or has a disability (if under age 18, an annuity payable to age 18 is available; if individual is financially dependent and has a disability, a roll-over to the beneficiary’s own plan is available). If any of these roll-overs are not available, the fair market value of the investments in the RRSP/RRIF at the time of death is generally included in the final tax return of the deceased. If the RRSP/RRIF investments have increased in value from the time between the annuitant’s death and the distribution to the beneficiary, the amount of the increase is generally included in the beneficiary’s income. On the other hand, the amount of any post-death decrease in the value of the RRSP/RRIF can be carried back and deducted against the deceased annuitant’s year of death income inclusion. Subsequent to the introduction of the TFSA, most provinces introduced legislation also allowing beneficiary designations for TFSAs. Where the TFSA holder designates a beneficiary (or beneficiaries), upon the death of the account holder the proceeds of the TFSA will be paid out to the beneficiary (or beneficiaries), and the TFSA will be closed. No tax will be payable by the deceased’s estate in respect of the TFSA, and the fair market value of the TFSA at death will be received tax free by the beneficiary; however, any income or growth post-death is taxable to the beneficiary.
Consider U.S. estate tax implications if you own U.S. investments
Investing in foreign assets, such as U.S. securities, provides an opportunity for diversification. However, U.S. estate tax could be a concern if you are a Canadian who owns U.S. property at death. The estate of a Canadian is potentially subject to U.S. estate tax if the value of U.S. property owned personally at death exceeds US$60,000, and the value of worldwide assets exceeds the Federal estate and gift tax exemption amount of US$13.99 million for deaths in 2025. U.S. estate tax generally escalates as the value of the estate increases. U.S. estate tax rates start at 18 per cent and increase to a maximum of 40 per cent. U.S. taxable property includes U.S. real estate, shares of U.S. corporations, many U.S. bonds and debts of a U.S. issuer, even if the investment is held in an RRSP, RRIF or TFSA. Canadian mutual funds that invest in U.S. securities or American Depository Receipts (“ADRs”) are generally not subject to U.S. estate tax. In Canada, estates are subject to Canadian income tax on accrued gains on all capital property owned upon death, including any U.S. taxable property (unless the property is left to a spouse or qualifying spousal trust). This means that your U.S. taxable property could attract U.S. estate tax, but it may also be subject to Canadian capital gains tax.
Seek advice
Please note that this article should not be construed as tax advice and individuals should consult with a tax advisor regarding their personal situation. For more information, speak with your BMO financial professional.