Canadians who managed to beat the March 3 registered retirement savings plan (RRSP) contribution deadline now have until April 30 to claim it on their income tax return if they want a refund in the spring.
A recent survey from IG Wealth Management found only 22 per cent of respondents pay attention to their taxes beyond their RRSP refund. 36 per cent, according to the survey, don’t even think it’s important.
Not having a tax strategy leaves less money for long- term investments and denies retirement savers potentially hundreds of thousands of dollars in compounded returns.
A qualified tax professional can provide a tailor-made strategy for individuals according to their financial circumstances.
There are four basic tax perks available to average investors that can be utilized and co-ordinated for maximum efficiency.
1. Reinvest your RRSP refund
The same IG Wealth Management survey found 57 per cent of respondents consider their RRSP refund a bonus to “treat themselves or their family.” 47 per cent said they reinvest their refund.
The idea that an RRSP refund is a bonus is a marketing myth that really means employers collected too much the previous year (usually through payroll deductions).
The RRSP is a great retirement savings tool because contributions can be deducted from your income to lower the previous year’s tax bill, and grow tax-free in investments for decades.
The biggest savings come to those with big incomes who would normally be taxed at a high marginal rate. As an example, if your top rate is forty per cent, your refund will be about forty per cent of your contribution.
Reinvesting your refund in your RRSP will not only add to the total amount compounding in investments over time but will also generate further refunds.
2. Balance RRSP contributions with a TFSA
There are limits to how much you can contribute to your RRSP but even they can be too much. Unfortunately, contributions and all the returns they generate over the years are fully taxed according to the going marginal tax rates when they are withdrawn.
You could be the victim of your own success - and even have some of your Old Age Security (OAS) benefits clawed back - if your annual RRSP withdrawals are taxed at a higher rate than the original contribution.
That’s when you need to plan into the future and determine how much of your savings and RRSP refunds should be channeled into your Tax-Free Savings Account.
Unlike RRSP contributions, TFSA contributions can not be deducted from income but they - along with any investment returns they generate - are not taxed when they are withdrawn. The only exception is dividends from U.S. equities.
You can adjust that balance according to each year’s income and over time as your retirement goals become clearer, but the ideal tax situation would allow you to draw income from your RRSP at a low marginal rate and top up any additional income from your TFSA (tax free).
3. Capital gains exemption in non-registered accounts
There are also contribution limits on TFSAs, but there are ways to incorporate investments in non-registered accounts into your tax strategy.
The biggest tax advantage outside of a TFSA or RRSP is the 50 per cent capital gains exemption, which only taxes half of the gains on stocks or other equity investment when they are sold.
There are limits for stratospheric amounts of capital gains that few Canadians ever near. Regardless, Prime Minister Mark Carney has vowed to nix an increase imposed on capital gains over $250,000 by former Prime Minister Justin Trudeau.
While a 50 per cent capital gains exemption is not as good as a 100 per cent exemption in a TFSA, investors in non-registered accounts can also benefit from market losses. Tax-loss selling permits the use of equity losses to recoup capital gains taxes already paid in the past three years or apply them against future capital gains.
The capital gains exemption also applies to the sale of company shares from employer share plans and most other equities purchased or obtained outside a registered account.
4. Dividend tax credit
If you’re looking for a tax perk with a ‘buy Canadian’ theme, credits can also be applied to dividend income from eligible Canadian corporations held in non-registered trading accounts.
Dividend tax credits are Canada’s way of reducing what is known as “double taxation” by offsetting dividend payouts already taxed to the corporation.
