lt may be frustrating when you compare your gross versus net income. Are you really paying that much in taxes? Where does the money go? We all feel the same pain, right from the time we earn our first pay cheque, and knowing that our taxes keep our roads safe, our medical bills low and our society operating smoothly sometimes doesn’t stop the anguish.
Geoff Chen, a High-Net-Worth Planner at TD Wealth, says that, besides paying for services we all use, the country also uses taxes to nudge our money into different areas. “Canada wants us to do certain activities by offering tax incentives and it also discourages us from other actions by the application of tax,” he says. He suggests these as the tax strategies everyone should look into.
Chen says one of the main components of tax strategy is to utilize tax-deferred or tax-friendly accounts: Registered Retirement Savings Plans (RRSPs), Registered Education Savings Plans (RESPs) and Tax-free Savings Accounts (TFSAs). Each plan defers or mitigates tax obligations in different ways.
Contributions to an RRSP lower your taxable income. You can generally contribute up to 18% of your previous year’s earned income up to an annual maximum ($27,830 for 2021). The investments in the plan can grow tax-free until you withdraw the funds. As the funds are geared to providing retirement income, the key is to withdraw the funds in retirement when your income — and therefore your tax rate — is potentially lower.
“Depending on your financial situation, if you contribute to an RRSP, your taxable income shrinks, and your tax obligation may decrease. You may even receive a tax refund,” Chen says.
The annual contribution limit for TFSAs is $6,000 for 2021. Contributions are made with after-tax dollars and no tax is applicable when amounts are withdrawn, meaning that investments can grow tax-free. TFSAs also offer some flexibility over RRSPs: Savers can access their funds (depending on their investment type) and the amounts withdrawn can be recontributed in a following tax year.
RESPs offer a method to save toward funding a child’s post-secondary education but also offer a tax saving opportunity. Like RRSPs, investments can grow tax-free within the plan and the growth is generally taxed in the hands of the recipient — the student whose tax rate is presumably less than the contributor. In addition, the federal government offers the Canada Education Savings Grant which can match 20% of up to $2,500 of the RESP contributions annually to a lifetime maximum of $7,200.
“Just as contributing to RRSPs lowers your taxable income, so too may income splitting. It means another opportunity to save tax,” Chen says. The following tax strategies only apply to spouses or common-law partners.
One goal of a spousal RRSP is to transfer funds from a higher income spouse to their lower income partner in order to provide them with more investment income.
“But the strategy also comes with tax benefits,” he says.
Income splitting can occur before retirement, through spousal RRSPs, or in retirement through splitting a pension. In a spousal RRSP, the higher income earner would contribute to the RRSP of the lower income spouse, within their available contribution limit. This transaction can result in a lower overall tax rate for the couple as the higher income spouse would receive a deduction for tax purposes in the year of contribution. Later, when the funds are withdrawn from the lower income spouse’s RRSP, the tax obligation on the RRSP withdrawal may be lower as it is taxed at the lower income spouse’s tax rate.
Chen notes that the Income Tax Act in Canada requires that the spouse receiving the funds must keep the funds in the RRSP account for three years. Otherwise, attribution rules kick in and the funds will be taxed in the hands of the higher-earning spouse.
Income splitting can also apply to pension income: The concept is much the same although the higher income earner can share up to 50% of their pension income. The common types of pensions that can be shared include annuity payments from RRSPs, payments from RRIFs, life annuities from a superannuation or pension plan. Pensions that can’t be split include Canada Pension Plan (CPP), Quebec Pension Plan (QPP) and Old Age Security (OAS).
This is a large part of financial planning when you sell your home. Usually, selling an asset such as an investment outside of a registered fund will result in a capital gain which is subject to tax. However, there is an exemption when you are selling your primary residence. Note, certain rules apply: In general, the home must be occupied by the homeowner and not be a rental property to claim the exemption. If the homeowner has a vacation property, a certain amount of planning may be needed to ensure that the largest gains are managed: If the vacation property has risen in value more than the home because it has been owned for a long period of time, it may be prudent to regard it as a principal residence in certain circumstances.
“Real estate that has been held for decades can generate enormous capital gains. The principal residence exemption is a powerful way to manage taxes and save money, especially for those who are using the sale of a home to fund retirement or healthcare needs,” says Chen.
But he says that each person’s situation is unique and consultation with a tax advisor on how to use the principal residence exemption is recommended.
Here’s a short list of some other areas to consider:
Moving expenses: If you have moved and established a new home for work or to run a business at a new location, you can deduct eligible moving expenses from the employment or self-employment income you earned at your new digs. Certain criteria must be met: For example, the move must be within Canada and more than 40 kilometres away from your previous home. Other rules apply if you are involved in an international move.
The Canada caregiver credit: Many Canadians are actively supporting relatives or dependents who are infirm or have disabilities. These activities can include a wide range of support, from providing food and accommodations to transportation to medical appointments. You may qualify for the caregiver credit if you provide services involving the necessities of life to a close relative or dependent with an impairment, even if the relative does not live in Canada. Certain documentation is needed from a medical practitioner to support your claim. To see who may qualify, see the CRA website1.
First-time home buyers’ amount: You can claim $5,000 if you or your spouse or common-law partner acquired a qualifying home (one existing or under construction). One qualification is that you must not have lived in another home owned by you or your spouse or common-law partner in the year of acquisition of the new home or in any of the four preceding years before the acquisition.
Medical expenses: There is a wide range of medical expenses that are eligible for the medical expense tax credit, but you can only claim an expense that you have not or will not be reimbursed for. Chen says to hold on to your receipts and submit the claim, even for small items because they do add up. You may also have to include supporting documents for your claim.
Chen says charities are one way the government offers incentives for generous acts. “Not only will you do a benevolent thing by giving to registered charity, but the government will give a tax credit for this action,” he says. You may be eligible to receive a credit of up to 33% of your donation at the federal level if your income is in the highest tax bracket and further tax credits at the provincial level. You can claim up to 75% of your net income and donations can be carried forward for up to five years.
Chen says those people who have embarked on estate planning may wish to consider donating investments to their favourite cause. As well as a tax credit, donating investments can offer a separate benefit: It can potentially eliminate the capital gains tax on eligible securities. Eligible investments include investments trading on designated stock exchanges, segregated funds, mutual funds, and government bonds. Calculating the tax benefits is complex. However, depending on your situation, donating the investments, and receiving a tax credit may be more beneficial, tax-wise, than selling the investments and facing capital gains.
Chen says the best time for using tax strategies is in the spring when we do our taxes. At that time, we can make RRSP contributions or spousal contributions and search for tax credits and deductions.
“It also gives you a moment when you can consider how much you have given in charitable donations. If you haven’t used your maximum, you can now begin to plan for next year.”
1 The Canada caregiver credit, Government of Canada, Updated Jan. 18, 2021, accessed Nov. 5, 2021. https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/about-your-tax-return/tax-return/completing-a-tax-return/deductions-credits-expenses/canada-caregiver-amount.html