Knowing how tax rules affect your investments is essential to maximize your after-tax return. Keeping up to date on changes to the tax rules is also important because they may open up new opportunities that could affect the way financial affairs are structured for Canadian-resident individuals.
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:
An interest-bearing loan at the prescribed interest rates to family members in a lower tax bracket. This strategy is particularly attractive because rates are currently at historically low levels.
Pension income splitting between spouses (or common law partners).
Gifts to adult children or other adult family members.
Gifts to a minor child – directly or through a trust structure – to acquire investments that generate only capital gains.
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 taxed at your marginal tax rate whereas you only pay tax on 50 per cent of a capital gain. Canadian dividends also receive special tax treatment through federal and provincial dividend gross-up and tax credit mechanisms. A new dividend tax regime exists for dividends paid by a Canadian corporation to a Canadian individual investor after 2005 which results in lower effective tax rates for these "eligible” dividends.
Your RRSP is likely one of the most important elements in 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 Allowable contributions to your RRSP are tax deductible and the income earned in an RRSP is not taxed until it is withdrawn, which means that your savings will grow faster than they would if held outside an RRSP. Some ideas to optimize use of your RRSP include maximizing your annual contribution limit, taking advantage of the extended deadline for collapsing an RRSP until age 71 and contributing to a spousal RRSP if you and your spouse/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 up to $6,000 annually to a registered account where income and withdrawals are tax-free. Because of its flexibility, a TFSA complements other existing registered savings plans for retirement and education. As a result, the TFSA is becoming an important investment vehicle for many Canadians.
A donation of qualifying 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. The fair market value of securities donated to charity will reduce your taxes through a charitable donation tax credit. On donations over $200 this can result in a tax savings of approximately 46 per cent of the value of the donation (depending on your province of residence). A donation of securities is considered a disposition for tax purposes. However, because of the tax incentives, on a donation of appreciated qualified securities to charity the capital gain inclusion rate is nil instead of the normal 50 per cent that would otherwise apply.
The benefits of Canada Education Savings Grants (CESGs), combined with other recent enhancements to Registered Education Savings Plans (RESPs), 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. The TFSA and Registered Disability Savings Plan (for disabled individuals) provide additional tax-efficient savings plans to fund children’s educational or other needs.
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 deductible investment related debt and speak with your tax advisor about structuring your borrowing to achieve tax deductibility.
Your estate plan can accommodate a number of tax-saving strategies to reduce or defer the amount of tax payable by your estate and maximize the amount available to your heirs. Some of the most common planning strategies include using a trust created in your Will to split investment income, naming a beneficiary for your RRSP/RRIF or TFSA, making charitable bequests in your Will and be questing appreciated assets to your spouse (or a qualifying spousal trust) to defer tax on the accrued capital gains.