It’s What You Keep That Counts
“It’s not only what you earn on your investments that is important, but how much of that you get to keep that counts. In this issue, we explore different investment tax strategies to help you keep more of what you earn.”
Tax deferred is tax saved.
RRSPs remain an extremely effective way to squirrel away savings for your future self. Most people are familiar with the immediate tax deduction (and savings) your RRSP contributions provide. However, the ability to grow those contributions and defer paying tax on that growth until the future is—in my opinion—an equally wonderful benefit. Growth in a non-registered investment can trigger immediate taxation. However, that same growth earned within an RRSP creates no immediate tax bill, allowing more of your money to stay invested and grow.
Furthermore, if you convert your RRSP savings into income when you are earning less (for example, when you sell your business or retire), you will also benefit from lower taxation. Converting that RRSP to a properly structured Registered Retirement Income Fund (RRIF) can mean less tax to the CRA and more income for you!
Income splitting: it’s not just for pensions!
If you have a child, an RESP is another great way to grow your savings, thanks in no small part to the Canada Education Savings Grant (CESG). For every $100 you save in an RESP, you earn a minimum $20 in CESG1 in addition to any interest earned. As with an RRSP, the interest earned on the contributions made to an RESP grows on a tax-deferred basis. In essence, only when the child is ready to pursue their post-secondary passions and you withdraw the funds does anyone claim that income. As a bonus, all the grant and interest get paid to the child as an Education Assistance Payment, not to the higher-earning contributor. As a student, that child often has very little other income to claim, resulting in little to no tax owing. This investment strategy allows interest earned on your money to be passed to your child at significant tax savings.
Another income-splitting strategy is found in the spousal RRSP. As a business owner, you probably have many expenses and therefore many opportunities to lower your taxable income. If you have a spouse or common-law partner who works in a traditional employee role, they may not have those same opportunities. Having them contribute to a spousal RRSP results in a tax deduction they may not be eligible for otherwise.
Income-splitting also transfers ownership of those spousal RRSP contributions to you, helping to build your nest egg. Whereas partners in traditional roles may have access to employer-sponsored pension plans or a group RRSP, entrepreneurs are often solely responsible for funding their retirement. If a partner with a pension plan is on track to have higher retirement income, transferring any additional retirement savings to you via the spousal RRSP not only provides tax savings today but creates the potential for tax savings when those monies are eventually withdrawn.
Avoid using your TFSA as a parking lot.
Too often financial institutions market Tax Free Savings Accounts as a place to simply park your short-term cash. The real power of the TFSA is in its ability to earn interest that accumulates tax-free and can be withdrawn tax-free. Read that again. Tax-free. If you are only earning a few dollars a year of interest in a high-interest savings account, I believe you are missing out on the true power of this investment vehicle.
As with all investments, its important to honour your investor profile (see last issue) and choose only investments that align with your risk tolerance and goals. Regardless, I suggest you park your short-term, emergency savings in a high-interest savings account and save your TFSA room for medium- to long-term goals.
Learn about your non-registered investments.
If you choose to invest outside a registered investment like a RRSP, TFSA, RESP, or any of the others mentioned, here are a few additional things you should know.
Interest income earned within a non-registered account will be treated the same as employment income and taxed accordingly in the year it is earned, regardless of whether you withdraw those monies from your portfolio.
Capital gains, on the other hand, provide an opportunity for tax deferral, as only when the property is sold is the tax liability triggered. Property can include things such as real estate or stocks in a company. A capital gain is realized when you sell property for more than you paid to acquire it. Currently, 50 percent of that gain is taxable and must be reported in the year of the sale. Any costs associated with buying or selling those assets, like legal and real estate fees, can be used to further reduce this gain, resulting in even more tax savings.
Finally, in our current market environment, GICs have fallen back into favour. Of course, GICs can be held within RRSP/Spousal RRSP, RRIF, RESP, and TFSA portfolios, but the taxation implications are different when they are held in a non-registered account. On a one-year GIC, interest must be reported as income on the maturity date. For multi-year GICs, interest is calculated and taxed at each anniversary date, as this is the date the CRA deems that it was “earned.” Multi-year market-linked GICs, on the other hand, may provide some tax deferral opportunities. These types of GIC are not normally taxed until maturity—which could be several years out—as only then can the exact earnings be calculated.
Invest with purpose and knowledge.
A solid investment strategy begins with knowing what you are trying to accomplish and understanding your options for getting there. It is important to think in terms not only of timelines and rates of return but also of tax consequences. Without this clarity, your good intentions could have unintended consequences.
1 Certain conditions apply. Full details at https://www.canada.ca/en/services/benefits/education/education-savings/savings-grant.html.
Jackie is a certified financial planner (CFP) and a certified health insurance specialist (CHS), with more than twenty years experience in financial services. She has built a fresh and forward-thinking financial planning practice that aims to educate and empower the clients it serves. Jackie recently led an initiative to help improve the financial literacy of the province’s youth and is a regular guest on local radio, where she helps people gain clarity on a wide array of financial topics. She also wrote a financial column for the Telegram, “The Invested Mama Minute,” for three years and is a past contributor to The Advisor.