You’ve done the hard work of setting aside savings. You’ve researched the investments that align with your financial goals. As your wealth grows, income tax can feel like a looming concern. Taking a positive view; however, it’s better to earn income and pay tax on it, than not to earn it at all. Furthermore, there are strategies you can use that will lessen the tax burden and increase your future spendable wealth.
Pillar #1: Defer
The later you pay tax, the longer that money can work for you. Because inflation erodes the value of money over time, it costs you less to pay tax using future dollars than to use today’s more valuable ones.
For example, in a non-registered account (any account that is not part of a registered government savings plan) you don’t pay tax on the increase in value of your investment until you sell or cash in. With registered accounts, such as a Registered Retirement Savings Plan (RRSP), you receive a tax deduction when you contribute, with the understanding that you will pay tax when you withdraw the funds, often years, or decades into the future, when you are likely to be taxed at a lower rate.
Pillar #2: Shelter
Registered plans such as RRSPs, Tax-free Savings Accounts (TFSAs), and First Home Savings Accounts (FHSAs) provide a tax shelter on the investment income earned while it’s inside the plan. While RRSP withdrawals are fully taxable when the funds are taken out, that is not the case with TFSAs. With a TFSA, withdrawals are not taxed, allowing both your original contributions and investment growth to be accessed tax-free. For FHSAs, this is also true as long as the funds are used to purchase your first home.
Pillar #3: Prefer
Not all types of income are taxed the same way. Employment income is fully taxable, as is income withdrawn from an RRSP.
In a personal non-registered account, interest income and foreign stock dividends are fully taxable each year as they are earned. However capital gains are taxed more favourably – generally only 50% of the gain is included in taxable income when you sell an investment. In addition, dividends from Canadian corporations benefit from the dividend tax credit, which reflects taxes already paid at the corporate level. This can be especially helpful for Canadians in low to mid-income tax brackets.
Pillar #4: Split
Income splitting focuses on who reports the income. Because Canada has a progressive tax system, higher levels of income are taxed at higher rates. Shifting income to a spouse or partner in a lower tax bracket can help reduce a household’s overall tax bill.
Contributing to an RRSP can be thought of as one form of income splitting – you are essentially splitting your income with future you. Spousal RRSPs also allow you to split your income with your spouse in retirement, and pension income splitting may allow up to 50% of your eligible pension income to be reported by your spouse each year. Income splitting can be complex, so seek out the advice of a trusted financial advisor.
Understanding how taxes work is an important part of financial wellbeing. With thoughtful planning and expert guidance, you can keep more of your hard-earned dollars working for you.
Meet with a member of our Wealth and Investment team to discuss investment tax planning and how you can save.
*This article is adapted from a document titled “Four Pillars of Investment Tax Planning” published by Aviso Wealth.
Mutual funds and other securities are offered through Aviso Wealth, a division of Aviso Financial Inc.
The information contained in this article was obtained from sources believed to be reliable; however, we cannot guarantee that it is accurate or complete. This material if for information and educational purposes and it is not intended to provide specific advice including, without limitation, investment, financial, tax or similar matters. This document is adapted from Aviso Wealth and unless indicated otherwise, all views expressed in this document are those of Aviso Wealth. The views expressed herein are subject to change without notice as markets change over time.