The excerpted article was written by Julia Mastroianni | Financial Post
Here are a few ideas:
Sheltering investment income
For any Canadian with the ability to save money, sheltering income from the taxman in one of the two main savings vehicles the government makes available is a no-brainer.
David Rotfleisch, founding tax lawyer of Toronto firm Rotfleisch and Samulovitch, recommends Registered Retirement Savings Plans (RRSPs) to everyone.
“You should be putting away the maximum you can into your RRSP. That in and of itself is the most important tax-saving tip and it’s available to everyone,” he said.
Contributions to an RRSP are tax-free, meaning you don’t have to pay any income tax on them in the year of the contribution. The funds can also be invested with no tax on gains until the age 71 — at which point a taxpayer must begin to withdraw funds, which are then treated as taxable income.
Tax-free savings accounts (TFSAs) are another option. While the money you contribute to your TFSA will be post-tax income, any interest, dividends or capital gains earned in it are tax-free for life, and you won’t have to pay taxes on the withdrawals.
Wealthy Canadians use these accounts too, though Jamie Golombek, managing director of tax and estate planning at CIBC, said they might use them a bit differently. They’re likely maxing out their RRSPs and TFSAs by contributing the yearly limit — but they aren’t stopping there.
“What the wealthy are doing beyond that is they are actually using TFSAs to fund for their children once the children reach the age of 18,” Golombek said. “So some wealthy families are giving money to their kids at 18 to encourage the kids to put money into their own TFSAs. And what that does is it’s able to transfer wealth intergenerationally while keeping all the investment income tax-free.”
Many wealthy Canadians run a side business (or their own business) for the benefits of lower tax rates, business write-offs and tax-deductible individual pension plans.
If you run a business, are self-employed or doing freelance and contract work, it’s worth considering incorporation. Barrett said the choice should depend on how you use the income you’re earning.
“If all the income that’s coming in is being consumed by you every year, then there’s no advantage,” he said. But if the money you’re making through self-employment, even if it’s a small side business, is extra money for you, incorporation has its benefits. The 2019 small business tax deduction rate was nine per cent after the federal tax abatement, meaning you’d be taxed at the much lower corporate rate on your income.
Before you incorporate, Rotfleisch said to evaluate whether it’s worth your time and money. “Incorporation costs a couple of thousand dollars, but then you have your accounting costs to do the financial statements and tax returns and that’s going to cost you around $1,500 dollars,” he said. “So you have to decide if it’s worth spending that for the other tax benefits.”
Income-splitting and prescribed rate loans
While this strategy is particularly effective for wealthier Canadians within the highest tax bracket, there are benefits for the average Canadian too. If one spouse is in a higher tax bracket than another, they may want to shift some of that taxable income to another family member, including children.
However, in Canada, if you just loan money to a family member, the money will be attributed back to you on your tax returns. Instead, you would need to set up a prescribed rate loan with the Canada Revenue Agency-approved interest rate (currently two per cent). As long as the family member pays that interest rate to you every year, the money you’ve loaned will count under their tax return. When loaned to a child or spouse who doesn’t earn any income, that money then becomes taxed at the lowest tax bracket.
Permanent life insurance
Most Canadians are familiar with term life insurance, which provides temporary coverage for a set time. Permanent life insurance, on the other hand, lasts for life. This life insurance comes with an investment component that grows free of annual taxation.
However, it’s not quite accessible to the average Canadian, as it’s sometimes six to 10 times the cost of term life insurance. Permanent life insurance is usually an additional investment option for the wealthy who have already maxed out their RRSPs, TFSAs and other investment options and know that they have extra income that they’d rather not pay taxes on every year.
Jennifer Poon, director of advanced planning at Scotia Wealth Management, said that this is an option normally favoured by wealthier Canadians because it’s a long-term investment. “You can’t always just lock up all your cash in a life insurance policy because this is a tax shelter,” she said.
Ultimately, Barrett noted, the more money you have, the more tax planning you can do with it. Average Canadians can try out these strategies, but the savings won’t come close to the thousands and millions that the wealthiest are saving every year.
But with the right planning, savings are still possible.
“Even if you’re making 60 grand a year, and you’re smart and you’re frugal, and you’ve done all your tax planning properly, you can still get some really good savings that may be meaningful to you at that kind of an income level,” he said.