Forward thinking planning combined with understanding and utilizing all available tax mitigation strategies is the key to tax success. Having a professional in your corner who understands and stays on top of the nuances of tax is critical to financial efficiency.
Recognizing how gains from stocks, bonds, mutual funds and other investment income (interest, dividend and foreign) are taxed differently is key to optimizing your after-tax rate-of-return. While evaluating investments based on their after-tax return is important, you should also consider such factors as the investment’s risk, the opportunity for capital appreciation, liquidity, and so on. It is also important to note that in most cases, you will retain more after-tax income from capital gains than either Canadian-sourced dividends or interest income.
If you have children, grandchildren, nieces or nephews you may wish to consider establishing a family trust to shift investment income that would otherwise be taxed in your hands at a high marginal tax rate, to the hands of your low-income family members. If properly structured, income earned in the trust and paid or made payable to the trust beneficiaries may be taxed at their marginal tax rate. Each person can receive certain amounts of income tax-free annually due to the tax credits that are available to individuals. The income earned in the family trust can also be used to pay for your child’s expenses (private school fees, lessons, gifts, etc.), which you may have been paying all these years with your after-tax dollars.
Utilizing Registered Investments
RRSP’s, TFSA’s, RESP’s etc all offer tax sheltered growth meaning that your investment returns compound year to year without being subject to taxation. Each registered account treats deposits and withdrawals differently and it’s important to understand how each account works in order to maximize where you save, and which accounts you make withdrawals from and when. For a full listing of accounts and how they work check out our Investment Account page.
Income splitting is the reallocation of income among family members (including spouse, minor and adult child) to reduce the total amount of money paid by the family unit. A well accepted tax planning method, shifting income from a family member in a high tax bracket to one in a lower tax bracket can result in greater after tax income. Although income attribution rules restrict the number of income-splitting opportunities available, there are still a number of effective ways of splitting income with family members.
If you have a low-income spouse, a spousal loan may be able to shift investment income to them. This will allow you to take advantage of your spouse’s lower marginal tax rate. The strategy involves you transferring funds to your low-income spouse through a formal loan arrangement at the CRA prescribed interest rate. Your spouse is then able to earn investment income on these funds and pay taxes at their lower marginal tax rate.
Tax Exempt Insurance
Permanent life insurance can provide large, tax efficient means of transferring funds between generations and between a corporation and its heirs. At death, your assets can trigger large taxable consequences and proceeds for insurance policies can be structured to pay out to beneficiaries tax free. Insurance proceeds can also increase the capital dividend account within a corporation to allows funds to pass from the corporation to shareholders with little to no taxation. Lastly, under the Federal Income Tax Act life insurance policies are able to accumulate assets within their contract on a tax-exempt basis which can provide an additional tax shelter for those already maximizing alternative tax sheltered strategies.