There
are a limited number of ways to reduce your taxes. Here are some
important planning considerations.
Tax Deferral
To
defer taxes, use capital gains-producing investments where, except
for distributions, tax is deferred until the investment is sold.
Only 50% of capital gains are subject to tax. Maximize use of RSPs.
RSP contributions have two advantages: (1) the initial contribution
is tax deductible, and (2) the growth of investments within the plan
is tax-sheltered until the funds are withdrawn.
Tax-Favoured Income
Not all
types of investment income are taxed alike and the rate of tax paid
will depend on your province of residence. Dividend income is
eligible for the dividend tax credit and so is less heavily taxed
than interest income (which is fully taxed). Capital gains also
enjoy a tax advantage, as only 50% of the actual gain realized are
taxed. To be equal after tax, an interest-bearing investment would
have to earn approximately 10% before tax, compared to a 7.8%
dividend or a 7% capital gain. For people in the highest marginal
tax bracket, approximately 48.64% of your interest income returns to
the government in tax, compared to only 37.32% of dividend income
and 24.32% of capital gains.
Asset Swap
If
you’ve maximized your RSP contributions, hold capital
gains-producing investments outside your RSP where you have access
to the deferral of unrealized capital gains, and where half of the
ultimate capital gain is tax-free. Hold interest-producing
investments within your RSP where they are sheltered from tax until
withdrawn. Overall, tax treatment may be improved without adding any
risk by switching capital gains investments within your RSP with
interest investments outside your RSP.
Retirement Income
Try to
equalize the retirement incomes of you and your spouse. The goal is
to have the same marginal tax bracket upon retirement, to minimize
your combined tax. The best way to achieve this is to accumulate
investments equally, using spousal RSPs where necessary. You will
need to factor pension incomes and unsheltered assets into your
calculations.
Splitting Investment Assets
If one
spouse is a higher income earner, a spousal RSP allows you to divide
your RSP contribution limit between your own RSP plan and the
spousal plan, to ensure assets are evenly distributed between both
spouses.
In
addition, the lower-earning spouse can invest his/her entire income
in a non-RSP account. It is acceptable for the higher income spouse
to pay all household expenses and pay taxes for both spouses. The
entire gross income of the lower-income spouse can then be invested
in their name, and therefore taxed in their lower income tax
bracket.
Tax Credit
You can
use the charitable donation tax credit to your advantage by ensuring
you declare more than $200 in donations in a given year. Charitable
donation receipts can be held for up to five years. Your taxes are
reduced by approximately 26% of the first $200 donation and
approximately 45% of the amount above $200 depending on your
province of residence.
Tax Shelters
We do
not recommend tax shelters. Tax shelters are typically high-risk
investments, which should be considered on the basis of their
investment merits and their suitability to your risk tolerance. Some
shelters are subject to less rigorous regulatory requirements and
scrutiny than securities offered by prospectus, and are therefore a
much higher risk than some people realize. Review the risk factors
carefully. Consult your accountant for tax advice, and your lawyer
for advice concerning your liability before proceeding.
Tax-Sheltered Investing in
Universal Life Insurance
Many
people are unaware of the tax-sheltering benefits that can be
achieved through funding a universal life insurance policy beyond
the minimum premium requirements. For people who are maximizing RSPs
and RESPs, have their debts under control, and have an interest in
maximizing their estate and sheltering more of their holdings from
taxation, universal life insurance can be a key consideration in
their financial planning.
Tax Deferral through
Incorporation
Incorporating in provinces where it is allowed can benefit
physicians who do not (or “have to”) draw all of their earning from
their practice. The first $225,000 in corporate earnings is taxed as
low as 18.12% in some provinces.
Joan McCarthy is a
financial consultant with MD Management’s Newfoundland and Labrador
regional office.
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