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Jan 06, 2022

Tax planning: Quick facts and common strategies

What better time to lay out your tax strategies and plans than the beginning of a new year? Especially when tax time will be here before we know it. In order to make those plans, having a good understanding of the “unwritten rules” of Canadian taxes can give you a decided advantage.

By Aaron Hector, B.Comm., CFP, R.F.P., TEP
As Vice President and Financial Consultant at Doherty & Bryant, an affiliate brand of CWB Wealth Management, Aaron’s comprehensive wealth management expertise consists of more than a decade of experience in the financial services industry. 

RRSP Quick Facts

The 2021 tax year RRSP contribution deadline: March 1, 2022.

Any person age 70 or younger as of January 1, 2021 can contribute to their RRSP as long as they have sufficient contribution room. Contribution room is based on earned income (such as employment income reported on a T4 slip). An RRSP must be converted to a RRIF by the end of the calendar year in which the person turned 71. If you have a younger spouse, you may be able to continue to make RRSP contributions into a Spousal RRSP in their name even after you are 71.

Unless you are a member of a pension plan, new RRSP contribution room for the 2021 tax year will have accrued based on 18% of your 2020 earned income, up to a maximum of $27,830. In addition to this, you may have unused contribution room from prior years. Therefore, prior to making a contribution you should always confirm your current contribution room by reviewing your most recent Notice of Assessment or Notice of Reassessment from the CRA, or by visiting My Account through the CRA website. Any contribution room remaining after March 1 will be available for future contributions.

 

Common RRSP Strategies

You may choose to contribute and deduct only as much as necessary to bring taxable income down to a certain level. Depending on your situation you may wish to try to:

  • Completely eliminate your tax owing for the year.
  • Bring your taxable income down to the top of the income bracket just below your current bracket. This allows for maximum value on each dollar contributed and saves unused contribution room for future years when income may be higher.
  • Bring your income down to a point where you avoid exposing yourself to a clawback of your Old Age Security (OAS). For the 2021 tax year, OAS clawback will begin if your net income exceeds $79,845.

 

It is worth noting that it is possible to contribute to an RRSP and not claim your tax deduction, or only deduct a portion of the contribution against your income for the current tax year. This can be a handy way to invest while receiving the most value from your contribution. The portion of your contribution that you do not apply as a deduction will be saved for use in a future year. For example, if you are expecting to make significantly more income in coming years than in the current tax year.

 

TFSA Quick Facts

There is no deadline to make TFSA contributions since these are not deducted from your income.

Canadian residents who were 18 years of age or older in 2009 (the year the TFSA was introduced) and have never made a contribution will have a cumulative contribution limit of $81,500, which includes $6,000 of new contribution room for the year 2022. If you already have a TFSA, your contribution limit will be $81,500, less the total of your lifetime contributions plus the total of your lifetime withdrawals. However, it is important to note that withdrawals from your TFSA will not increase your contribution room until January 1 of the next calendar year.

 

Common TFSA Strategies

Within the context of an appropriate overall asset mix, you could look to maximize growth opportunities inside your TFSA as the full upside will be tax-free. However, it is important to note that losses cannot be used to offset capital gains incurred within taxable accounts.

Conservative investors who do not typically invest in equity markets may wish to shield interest bearing investments within TFSA accounts, rather than focussing on growth.

When you invest in foreign dividend-paying companies, the foreign government will withhold a percentage of the dividend back as a withholding tax. When this occurs within a TFSA, you lose the ability to claim a foreign tax credit on your tax return the way you could if the same were to incur within a non-registered account. As a result, there is a small amount of effective tax that is paid by TFSA investors. Due to this, some investors will choose to focus on capital appreciation rather than dividend yield when picking foreign investments inside TFSA accounts.

If you are undecided as to whether it makes more sense to contribute to your RRSP or your TFSA, you may choose to make a TFSA contribution rather than suffering from decision paralysis and missing out on an opportunity. The reason for this is that in the future it is easy to take money out of your TFSA and then shift that into your RRSP. However, going the other way (from RRSP to TFSA) doesn’t work very well due to the tax implications of making RRSP withdrawals.

TFSAs make sense for nearly every Canadian age 18 and over.

 

Getting Ready To File Your Tax Return - Common Deductions and Credits

Tax Deductions
A tax deduction will reduce the amount of your income that will be subject to the tax calculation. For example, if your gross income was $100,000 and you had tax deductions totaling $10,000 then you would only pay tax on $90,000 of income. Those who are exposed to higher marginal tax rates will receive a higher benefit for their tax deductions than those who are in lower tax brackets. The following list is not exhaustive, but rather some of the more common deductions that may be applicable to your tax situation:

 

  • RRSP contribution deduction.
  • Carrying charges (investment management fees) for non-registered investment accounts.
  • Deduction for splitting pension income with a spouse. The amount split would be deducted from the pensioner’s income and added to the spouse.
  • Interest paid to your spouse on family income splitting loans.
  • Interest paid on money borrowed to invest inside non-registered investment accounts.
  • The simplified method of claiming employment expenses for working from home due to COVID-19 has been renewed for the 2021 tax season.

 

Tax Credits

Tax credits are often confused with tax deductions, and while they both enhance your tax position, they do so in a different way. While a deduction reduces the amount of income subject to the tax calculation, a credit is applied as a reduction to the tax payable after the calculation takes place. So, if you have $1,000 of tax to pay, and you have a $100 tax credit, then after applying your credit you would only have $900 to pay. For this reason, so long as tax credits can be utilized, they are worth the same amount to those who are in lower tax brackets as they are to those in higher tax brackets. The following list is not exhaustive, but rather a listing of some of the more common credits that may be applicable to your tax situation:

 

  • Basic personal tax credit. This is an amount available to everyone that ensures that a minimum level of income can be received without taxation.
  • Spouse or common-law partner tax credit. If one spouse does not have enough income to utilize all of their basic personal tax credit amounts, the unused portion can be transferred to their spouse.
  • Donation tax credit. Donations earn a higher tax credit when they exceed $200, so putting all donations on one spouse’ tax return will require you to break through the $200 threshold only one time. If you have taxable income that is exposed to the top federal tax bracket then you get an additional 4% return on your donations. Note that each province has a different donation credit rules and some provinces are more generous than others. For significant donations it is recommended that you make charitable donations by donating shares with a large unrealized capital gain rather than donating cash.
  • Political donation tax credits. Similar to charitable donations but reported separately.
  • Pension income tax credit on up to $2,000 of eligible pension income. If you have a spouse but only one of you has eligible pension income, then this credit can be used twice so long as you split at least $2,000 of eligible pension income splitting on your tax return. A common misunderstanding is that this allows for $2,000 of pension income to be received “tax-free”; however, that is only the case if your income is within the lowest tax bracket. If your income is exposed to higher tax rates, this credit will still reduce your tax payable on the $2,000 of pension income but there will still be some tax to pay.
  • Medical expense tax credit. This tax credit is generally best reported on the tax return of the lower income spouse as there is a threshold that needs to be passed and the threshold is based on net income. A caveat to this is that you would not report the medical expenses on someone’s tax return if they do not have any tax to pay. Medical expenses can be claimed for any 12 month period, so long as the period ends within the current tax year. Medical expenses do not need to be claimed for the January 1 to December 31 calendar period if there is a more optimal 12 month period that you can apply.
  • The disability tax credit is a valuable tax credit that also opens the door to various government assistance programs and also the Registered Disability Savings Account (RDSP). You must first apply for the disability tax credit and be approved before you can claim the credit on your tax return. If it is deemed that you would have been eligible for the credit in prior years, then your prior year tax credits can be (should be) adjusted retroactively.
  • Digital news subscription expenses that are qualified by CRA.

 

There are many details involved in a comprehensive financial plan and optimizing your tax planning is just one of them. Every person’s circumstances are unique and should be reviewed by a Financial Planning Professional to ensure you have a solid understanding of your tax situation. Please reach out, we are happy to answer any questions you may have.