Nothing erodes a person’s finances more quickly than paying unnecessary taxes! While taxation is a necessity for a functioning society, paying more than you are required to is a detriment to yourself. The Canadian tax code allows us some flexibility to structure our affairs to be tax efficient, and these are a few tips to help you do so:
- Take RRIF Payments over RRSP Withdrawals. On the surface, this seems like a “po-tae-to / po-tah-to” scenario. Registered retirement income funds (RRIFs) are just a registered retirement savings plan (RRSP) income stream, so why would one be better than the other? RRIF payments are one of the eligible income sources for claiming the Pension Income Tax Credit while RRSP withdrawals are not. The Pension Income Tax Credit is a non-refundable tax credit on the first $2,000 of pension income earned in a year. If you have no other pension income, taking a RRIF payment will earn you a credit that RRSP money can’t!
- Allocate Tax-Preferred Investments to Non-Registered Accounts. Not all forms of investment income are taxed the same. Rent and interest are taxed at your marginal tax rate, capital gains are only half-taxed and eligible Canadian dividends earn you the Dividend Tax Credit. If you have both registered and non-registered investments, consider skewing your holdings so that the interest-bearing investments are tax-deferred while the capital gain and dividend-earning holdings sit in your non-registered accounts.
- Avoid Registered Withdrawals for Lump Sum Purchases. If you have a lump sum purchase coming up (new car, vacation, home renovation, etc.), avoid taking the funds for that project out of registered accounts like RRSPs, RRIFs, or life income funds (LIFs). Lump sum withdrawal from registered accounts are subject to withholding tax, then reconciled when you file your tax return for a refund or potentially additional tax owing. To get $10,000 out of your RRSP for example, you’ll need to redeem $12,500 pre-tax as 20% is withheld on redemption. These kinds of redemptions deplete your investment capital in a hurry!
- Time Your Income When Possible. If you have options to time your income payments across different tax years, it may be of a significant advantage to do so! For example, if you have a large severance benefit when you retire, consider retiring at the beginning of next year instead of the end of this year. That way you won’t have 10 or 11 months of taxable salary bumping up your tax bracket when the money comes in. Same with starting a Canada Pension Plan (CPP) or Old Age Security (OAS). If possible, deferring the start dates to the start of a year with lower taxable income can maximize the tax savings of your decision!
Being tax-smart with your retirement can add significant financial security and flexibility to your plans! As always, with any tax planning, you should confirm these decisions with your accountant to ensure they’re applicable to your circumstances.
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