We’ll look at some advantages of using RRSPs, TFSAs, and FHSAs to optimize tax efficiency, and how tax deductions versus tax credits can benefit you in different ways.
RRSP Quick FactsThe 2023 tax year RRSP contribution deadline is February 29, 2024.
Persons younger than 71 as of January 1, 2024, can contribute to their RRSP if 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 age 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’re a member of a pension plan, new RRSP contribution room for the 2023 tax year will have accrued based on 18% of your 2022 earned income, up to a maximum of $30,780. In addition to this, you may have unused contribution room from prior years. This is because it’s 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. You may decide to do this if you’re expecting to make significantly more income in coming years than in the current tax year. This can be a handy way to invest while receiving the most value from your contribution. 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.
RRSP Common Strategies
You may choose to contribute and deduct only as much as necessary to bring taxable income down to a certain level. However, depending on your situation, you could use an RRSP 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 2023 tax year, OAS clawback will begin if your net income exceeds $86,912.
TFSA Quick Facts
There is no tax deadline related to making TFSA contributions, since these are not deducted from your income, and if you don’t make a contribution this year then you can get caught up again in a future year.
TFSAs make sense for nearly every Canadian age 18 and over. Residents who were 18 years of age or older in 2009 (the year the TFSA was introduced) and have never contributed will have a cumulative contribution limit of $95,000, which includes $7,000 of new contribution room for the year 2024. If you already have a TFSA, your contribution limit will be $95,000, less the total of your lifetime contributions plus the total of your lifetime withdrawals. However, it’s important to note that withdrawals from your TFSA will not increase your contribution room until January 1 of the next calendar year.
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. But it’s important to note that losses cannot be used to offset capital gains incurred within taxable accounts. Conservative investors, who don’t typically invest in equity markets, may wish to shield interest-bearing investments within TFSA accounts rather than focus 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’s a small amount of effective tax that’s 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’re undecided as to whether it makes more sense to contribute to your RRSP or your TFSA, it may be a good idea to make a TFSA contribution rather than suffer from decision paralysis and miss out on an opportunity. The reason being that, in the future, it’s easy to shift money from your TFSA into your RRSP. However, going from an RRSP to a TFSA doesn’t work as well due to the tax implications of making RRSP withdrawals.
FHSA Quick Facts
2023 brought a new tax-advantaged savings account for Canadian residents who are saving for their first home purchase: the First Home Savings Account (FHSA).
The contribution limit is $8,000 per year, however, if you opened an FHSA in a prior year then you may have accumulated contribution carry forward room if you did not contribute $8,000 each year since it was opened. There is also a lifetime contribution limit of $40,000. Your contributions will attract a tax deduction, like an RRSP, and if you use the funds to assist you in buying a home at some point in the following 15 years, then the withdrawal (consisting of both contributions and growth) will be tax-free, like a TFSA. For more details on this new account, see our two-part FHSA series:
- Part 1: Alternative ways to fund and use an FHSA
- Part 2: Planning ahead with the FHSA to optimize tax benefits
The tax deduction on FHSA contributions can be carried forward and used in a future tax year, like RRSP tax deductions. However, the annual contribution period is January 1 to December 31, which is different from RRSP contributions where the annual contribution period ends 60 days into the following year.
It’s wise to open an account and start contributing if you have a goal of buying a home within the next 15 years. It will take five years of full annual contributions to maximize the lifetime contribution limit of $40,000 – so start early!
If you don’t have cash to contribute to your FHSA, you can move money from your TFSA into your FHSA. Your TFSA contribution room will replenish itself as of January 1 of the following year.
You can also transfer money from your RRSP into your FHSA account, but your RRSP contribution room will not be replenished (like the TFSA) if you do this, and you won’t get another tax deduction. It will, however, let you withdraw the money out of your FHSA tax-free in the future when you buy a home.
Summary of limits for 2023/2024
|RRSP max new contribution room
|TFSA new contribution room
|OAS clawback threshold
|FHSA contribution room1
1 Need to have FHSA account opened to accrue contribution room.
Getting Ready to File Your Tax Return - Deductions and Credits
Tax deductions reduce the amount of your income that will be subject to being taxed. 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 shows some of the more common deductions that may apply 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’s income
- 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 NOT been renewed for the 2023 tax season
Tax credits are often confused with tax deductions. While they both enhance your tax position, they do so in different ways. A deduction reduces the amount of income subject to the tax calculation, whereas a credit is applied as a reduction to the tax payable after the calculation takes place.
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, as long as tax credits can be utilized they’re worth the same amount to those who are in lower tax brackets as they are to those in higher brackets.
The following list shows some of the more common credits that may apply to your tax situation:
- Basic personal tax credit. This is an amount available to everyone that ensures a minimum level of income can be received without taxation.
- Spouse or common-law partner tax credit. If one spouse doesn’t 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’s tax return will require you to break through the $200 threshold only one time. If you have taxable income that’s 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. It’s recommended that you make any significant charitable donations by donating shares with a large unrealized capital gain rather than giving cash.
- Political donation tax credits. These are similar to charitable donations but are 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 provided that 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, but that’s 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 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’s a threshold that needs to be passed, which 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 don’t have any tax to pay. Medical expenses can be claimed for any 12-month period, provided 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, as well as 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’s deemed that you would have been eligible for the credit in prior years, then your prior year tax credits can, and should, be adjusted retroactively.
- Digital news subscription expenses that are qualified by the CRA can be claimed as a tax credit.
While these strategies can get you thinking about your own situation more deeply, there are many nuances to tax optimization that come to light through a comprehensive financial plan. Reviewing your circumstances with a Financial Planning professional can give you a better understanding of the tax-saving opportunities that you might be missing out on. Please reach out to us if you’ve got questions or would like to know more.
Sources: Canada Revenue Agency, Chartered Professional Accountants Canada, Government of Canada
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