With careful planning taxes can be minimized or postponed, making the most of every dollar you have. There are many ways to minimize your taxes, and each method may have several variations. Investing in assets that have lower relative tax rates, tax shelter utilization, income splitting, and changing the nature of the inflow of income or how a business or trust is structured can help reduce the amount of dollars you pay out each year in taxes. As you age, your tax planning concerns change.
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Below are a few strategies that you may find useful for your current life stage.
There are numerous types of registered investment vehicles available to help you save on a tax-efficient basis: Registered Retirement Savings Plans (RRSPs), Tax Free Savings Account (TFSAs), Registered Retirement Income Funds (RRIFs), Locked-in Retirement Accounts (LIRAs), Life Income Funds (LIFs), and Locked-In Retirement Income Funds (LRIFs).
RRIF & LIF Age / Amount
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.
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. And 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.
When interest rates are low, you may be attracted by the strategy of borrowing to invest, also known as leveraged investing. This can be done though a brokerage margin account or various types of bank loans. Unfortunately, when deciding whether to use leverage, many people simply consider the current interest-rate environment and past market performance without evaluating their complete financial situation. Borrowing money to purchase investments is definitely not a strategy for the faint of heart. It involves significant resolve as well as various factors that should be considered and adhered to.
There are two types of savings plans many investors consider when putting aside money for a child’s post-secondary education: · A Registered Education Savings Plan (RESP) is a tax-effective method of saving as income earned in a RESP (and not withdrawn) is tax deferred.
· An In-Trust account offers a unique opportunity to split investment income among family members and thus benefit from a lower overall tax burden. Although income earned in a RESP is tax deferred until withdrawn, annual contributions are limited and are not tax deductible. In contrast, income earned in an In-Trust Account is taxable each year. However, there are no limits to the amount of contributions, making it a flexible alternative.
As a result of changes to the Canadian tax system over the last several years, the tax advantages associated with Canadian investment holding companies have all but been eliminated. It is no longer possible to defer taxes through an investment holding company and, in general, the combined corporate/shareholder tax rates on investment income now exceeds the personal taxes paid on the same income. Despite the changes in the tax system, investing through an investment holding company can still provide some benefits. For example, an investment holding company can be used to:
· Split income with adult children - Assets can be transferred into the holding company on a tax-deferred basis and the adult children can subscribe for shares of the company. Dividends can then be paid to the adult children and taxed in their hands.
· Freeze an estate - The primary goal of an estate freeze is to “freeze” a company’s share value for the original shareholders, while ensuring that future increases in the fair market value of the company pass to the next generation or to other desired individuals. This way, the amount of income taxes at death and probate tax can be minimized.
· U.S. Estate Taxes - Another reason for using a bona fide Canadian investment holding company is to hold U.S. situs investments in order to shelter a Canadian resident shareholder from U.S. Estate Taxes. The pros and cons of this type of strategy are complex and you should seek a professional tax consultant well versed in this area.