Increase Investment Returns with Year-End Tax Planning

It’s too bad so many people miss out on year-end tax planning for the family. Tax planning is about what you keep: what’s left of your income and capital after taxes are paid. Now is a great time for advisors and clients to review what can be done to lessen this year’s tax load.

Understanding your lifetime tax obligation is an important motivator because it underscores the magnitude of tax savings possible. Here’s a reality check: Find the amount of taxes paid last year on Line 435 of the T1 tax return. Now multiply that figure by an average working lifetime of 40 years. It’s probably a big number. In families where there are other working adults, the number can be huge.

The conclusion is not difficult: The tax burden we bear over our lifetime is very costly—not only income tax, but also all the other taxes we pay on consumption, property taxes, sin taxes and so on. But for most families, the income tax they pay year over year is their single greatest lifetime expense. The good news? Income taxes are also the only type of taxes for which there is an option to rearrange your affairs—within the framework of the law—to pay the least amount possible. You need only pay the correct amount, not more, and can use tax planning techniques legally available to you to reduce significantly the family’s lifetime tax bill. It’s your right as a taxpayer.

The final quarter of the year—October to December—is a very good time to review what can be done to make sure this year’s tax liability is as low as it can be for every member of the family. If you are a tax or financial planning professional, this is a critical time to see your clients.

Start with some tax literacy. My rule on this has always been simple: there is no such thing as a stupid tax question, especially at year end. For example, most people don’t understand what tax bracket their income falls into. That’s important for high-income earners who are subject to a new high-income tax bracket with a 33% federal tax rate. It’s also important for middle-income earners, who have received a tax reduction in their brackets.

When you understand your marginal tax rate—how much tax you’ll pay on the next dollar you earn—you’ll carefully choose the type of income that provides the best tax results. Most people don’t know that income diversification is a great way to save tax dollars. That is, different income sources are taxed in different ways. To build wealth efficiently, the focus is on those assets or investments that have the lowest tax cost at the time of investment, during growth periods and at withdrawal or transition to the next generation.

Income splitting, income deferral and income diversification all can add to a family’s net worth. So can the refundable and non-refundable tax credits a family may qualify for. This year, family income splitting has been discontinued; but a more generous Canada Child Benefit has been introduced for some families. Investing the money in the hands of a child can render resulting investment earnings tax free, provided the money in the account is not tainted by funds sourced back to an adult.

Refundable and non-refundable tax credits can also grow when RRSP planning is introduced to the family. RRSPs will reduce family net income, the figure upon which tax credits are based.

A bigger tax refund or more tax credits in the pocket make it possible for taxpayers who are at least 18 and residents of Canada to invest more tax-paid funds into the wonderfully tax-efficient TFSA. All earnings are tax exempt and TFSA contribution room never dissipates, if the money is withdrawn to fund a certain need. Lots of Canadians have underfunded their TFSA; those who have never contributed have $46,500 in investment room this year. Perhaps an inheritance or severance package would fit nicely there.

In many cases, paying investment costs like interest or management fees is a necessary component of the wealth building process. The lower the fees and costs, the easier it is for money managers and lenders to add long-term value to family wealth. That’s important, too, because certain other wealth eroders are uncontrollable: the cost of inflation, for example, or unexpected risks from currency fluctuations or political change. However, in some cases, investment costs are deductible as a carrying charge.

And don’t forget: there may be no need to pay that final quarterly tax instalment on December 15 if your income levels were reduced from last year’s results.

Astute advisors will help their clients estimate their income and the correct amount to pay. A tax specialist will take the time to analyze investment results, topping up tax-efficient investments, and assembling receipts to take advantage of the myriad of new tax preferences available this year—from home renovation tax credits to teacher’s school supplies, charitable donations or medical expenses, every little bit helps. Business owners will want to review whether to buy a new car, or other assets for use in their enterprise for an additional write-off before year end.

To more rapidly acquire, grow, protect and transition sustainable family wealth, advisors and clients should consider a proper order of investing now. This year end, consider what should come first—the RRSP or the TFSA, the RESP or the RDSP, interest- or dividend-producing investments—and whether any capital losses be harvested to offset taxable gains.

Evelyn Jacks is President of Knowledge Bureau and author of 52 books on tax and personal wealth management. Meet Evelyn on the Year-End Investment and Family Business Planning Workshop tour this November. Follow Evelyn on Twitter at @EvelynJacks.

Real Estate Continues To Make Canadians Wealthier

Statistics Canada’s issued two reports on September 15; one reporting good news on the value of household wealth; the other showing that the value of employer-sponsored pension funds declined. Meanwhile, the Conference Board of Canada reports that while global growth prospects are weak in 2016, economies that can recreate in light of a great paradigm shift will growth exponentially.

While national net worth declined slightly in the second quarter from $265,200 to $264,600, on a per capital basis, household net worth was up almost 2% to $9,837 billion; an average of $271,300 on average. The main reason was gains in the value of real estate holdings, which rose 2.2%. But financial holdings grew too: 1.7%.

Households borrowed more too: $29.2 billion, which was an increase of $3.5 billion from the first quarter; mortgages represented more than half – 65% – of that increase. On a seasonally adjusted basis, the household debt service ratio increased only slightly from 14.1% to 14.2%. Low interest rates have really helped here. At historic lows, Canadians have been able to use more of their mortgage payment to pay down principle.

That may be a very good thing, as the market value of employer-sponsored pension funds declined by 1.3% to $1.6 trillion in the first quarter of the year. Over 6 million Canadians are members of employer sponsored funds, with the vast majority of the funds (83.3%) being managed by trusteed funds. The remaining members’ assets are managed by insurance company contracts.

The value of pension funds held in stock was a big part of the decline: stocks fell 3.1% in the first quarter; bonds fared a bit better with a decline of only 2.2%. Real estate holdings in pension funds continued to do well: an increase of 3.4% was noted.

Also noteworthy: the value of foreign investments held in Canadian pension funds declined by 6.0% in the first quarter. These assets make up one third of total pension fund assets. The report went on to note the following for the first quarter of the year:

  • Employer and employee contributions decreased by 10.2%
  • Investment income was down 23.1%
  • Profits from the sale of securities was down 68.9%
  • Expenses, primarily due to increased losses on the sale of securities, were up 22.2%.
  • As a result, net income fell to $6.1 billion in the first quarter, down from $29.7 Billion in the fourth quarter of 2015.

The Canada Pension Plan posted its June 30, 2016 results in mid-August, indicating a gross investment return of 1.53%; net 1.45%. Its net assets were $287.3 Billion and net investment returns contributed $4.1 billion to the pot after all costs and contributions.

The bottom line? The ability to save in a low-interest environment enable tax-wise Canadians to assemble an impressive portfolio of financial and non-financial assets. Together with contributions to the CPP, and well managed debt, the future looks good for most working Canadians, as they accumulate and growth their household wealth.

Tips to Minimize Instalment Payments

September 15 is the date on which the third quarterly tax instalment must be remitted to CRA, to avoid interest costs on amounts owing for 2016. CRA may have sent a notice, but is the amount shown on it what is really owed? Now is the time to consider the options you have in payment methods and project income for 2016 . . Here are our top three tips for managing quarterly instalments to remit the correct amount, but no more.

  1. Know What’s Required. The law requires payment of the correct amount of tax, but no more. To begin, estimate your total income for 2016 by using the Knowledge Bureau’s Income Tax Estimator to do so. Click here for a free trial.
  2. Managing Tax Withholdings. Taxpayers who have employment income and other sources, such as investment and rental income, should review two CRA tax forms specifically designed to ensure that tax withholding properly matches income tax payable.
  • The TD1 Personal Tax Credits Return is designed to match tax withholding with personal non-refundable credits. To ensure withholding is not excessive, taxpayers must ensure that they claim for all of their personal tax credits when completing the form. Taxpayers with certain tax deductions, such as RRSP contributions, child care, spousal support, etc. may further reduce withholding by completing form T1213 Request to Reduce Tax Deductions at Source.
  • Managing Tax Remittances. Quarterly instalment tax remittances are required only when taxpayers owe more than $3000 at the time their returns are filed. Taxpayers who owe less than $3,000 annually can manage their upcoming balances due on the 2016 tax return as follows:
    • Do nothing and pay the balance owing by the filing due date, May 1, 2017 (or June 15, 2017, for unincorporated self-employed people)
    • Request additional withholding from other remitters at source (i.e., off the top of payments from CPP, OAS, RRSP or RRIFs)
    • Prepay their taxes by making instalment payments

Taxpayers who owe more than $3,000 in the current tax year and one of the prior two tax years are required to make quarterly instalment payments (annual for farmers and fishers). These taxpayers have three options:

  • Pay the amount requested by CRA[1]
  • Pay one-quarter of their prior-year balance in four equal instalments
  • Pay one-quarter of their estimated current-year tax liability in four equal instalments

If the first option is chosen, no penalty or interest will be charged regardless of whether the instalments are insufficient. If either of the other two options is chosen, taxpayers are liable for a penalty for late or insufficient instalments if the amount paid is less than the liability determined when the return is filed.

Year-end Planning Opportunities. Regardless of which method is used, taxpayers should estimate their tax liability prior to the last instalment due date (December 15) to determine whether the last instalment should be reduced or eliminated. This is an important part of all year-end tax planning activities. There is no point in taking money out of the markets and sending it to CRA in December, only to have it returned with no interest when the return is filed months later.

Another option is to review charitable donations for the year and consider transferring publicly traded shares with accrued gains to qualifying charities to take advantage of two tax planning moves: no tax on the capital gain and a charitable donation credit that offsets other taxes payable.

For more information experience your professional education differently: come to DAW, DAC or take an online certificate course, available 24/7.

[1]CRA’s instalment amounts for the first two quarters are each 25% of the balance due on the return for the second prior year. The third and fourth instalments are each 50% of the difference between the prior year balance due and the sum of the first two instalments.

©2016 Knowledge Bureau Inc. All Rights Reserved.

TAX TIP: Top Three Tax Investments for Education Funding

Statistics Canada reports that an undergraduate degree costs close to $6200 but according to a new study,  80% of parents don’t know that.  Worse,  most parents are poorly informed about tax efficient ways to save, especially weak on RESP knowledge.  This is a great opportunity for tax and financial advisors to add significant value. In this article on education funding, find out more about the RESP, the TFSA and the RRSP as funding options.

TFSA: Deposits to a TFSA are made with tax-paid dollars (there is no deduction for the deposit), but grow quickly because the investment income earned in them is always tax-free. The holder of the TFSA must be at least 18 years old at the time of the deposit and also must be a resident of Canada. The deposit may be made by the parents, grandparents, or anyone else who wishes to make the contribution. When the money is withdrawn, TFSA contribution room is not lost, meaning it can be replenished for other purposes, like buying a home after graduation.

By accumulating funds in a TFSA for their children, and/or starting a TFSA when their child turns 18, parents also avoid a tax liability in the future if the child doesn’t attend school; not so for the RESP, discussed below. TFSA contributions are limited to an annual contribution room currently $5,500. Since inception, TFSA contribution room has grown to $46,500, which can be topped up anytime.

RESP: RESPs allow parents to accumulate savings for their children on a tax-deferred basis with the added bonus of government grants of up to 20% of the first $2,500 contributed by the parent. The maximum annual grant is $500 but catch-up grants of up to $1,000 are available. The maximum contributions to the plan are $50,000 per beneficiary. For low-income families an annual Canada Learning Bond is also available even if no contributions are made by the parents.

If the beneficiary becomes a full-time student, the funds (called Education Assistance Payments – EAPs) are taxable to the student. But due to low income levels, that’s often nil. If the beneficiary does not become a student, the grants and bonds must be repaid and any amounts earned in the plan must be included in income of the contributor, with a 20% penalty over and above the normal tax rate. (This is called an Accumulated Income Payment). However if the contributor has RRSP contribution room, up to $50,000 may be transferred into the RRSP, resulting in deferred taxation.

RRSP Lifelong Learning Plan (LLP) Withdrawals: Students who have an RRSP and are residents of Canada, may be able to withdraw funds to fund their education from their own RRSPs, on a tax free under the LLP. (Note, you cannot fund your child’s education with an LLP withdrawal). The money must later be repaid, over a maximum of ten years. The following are conditions must be met to qualify:

  • The student must be enrolled full time in a designated educational institute or qualifying educational program (or has received an offer to enrol before March of the next year).
  • Full time means lasting three consecutive months or more and requiring 10 hours or more per week on the course or work in the program, including lectures, practical training, lab or research time, but not study time. The educational institution determines who is a full-time or part-time student.
  • The qualifying educational program requirement is possible for courses taken by correspondence or for a distance education program.
  • The institution may consider the student to be enrolled on a part-time basis. If this is the case, the student cannot participate in the LLP. The only exception to this rule is those who are disabled, who can attend part-time.

Students who study with Knowledge Bureau may qualify for some or all of these funding options. Knowledge Bureau will consider the student to be in full time attendance if that student enrols in a designation program which is completed in 5 months.