Financial Focus: Six principles of tax-smart investing

By Medicine Hat News on April 7, 2018.

Following are six principles to help you enhance your after-tax investment returns.

1. Focusing on your after-tax returns can — literally — pay dividends

Interest income (e.g. from GICs or bonds) is fully taxable at your marginal tax rate. However, only one half of any capital gain (e.g. from selling a stock that has increased in value) is taxable at your marginal rate. And eligible Canadian-source dividends are generally taxed even less, depending on your province. In fact, you can earn between $20,000 — $50,000 in tax-free dividends if you have no other source income (varies by province).

2. Maximizing your RRSP means more than just maximizing your RRSP contributions

Your Registered Retirement Savings Plan (RRSP) offers two well-known tax advantages: RRSP contributions are tax-deductible and grow free of annual taxes. There are several ways to make the most of these advantages, beyond simply maximizing your contributions every year. For example, if your annual income fluctuates, consider making your RRSP contribution as usual in a lower-income year, but wait until a higher-income year to claim it for a potentially greater tax deduction. Another strategy is to shelter investments with higher tax rates, within your RRSP.

3. Don’t settle for just tax-deferred growth when you can get tax-free growth too

With an RRSP, your investment earnings grow on tax-deferred basis — meaning you don’t pay tax until you actually start making withdrawals. With the Tax-Free Savings Account (TFSA), on the other hand, your investment earnings grow on a tax-free basis — meaning you never pay tax, even when you make withdrawals.

This has some people wondering whether they should still contribute to their RRSP — or just go with a TFSA. However, in most cases, it makes sense to contribute to both. Your RRSP is designed for a specific purpose — saving for your retirement. It also offers the ability to make much larger contributions — and they also are tax-deductible. Your TFSA, meanwhile, is more flexible, allowing tax-free withdrawals at any time for any reason — and the amount withdrawn is added back to your available contribution room the following year.

4. Create a tax-efficient retirement income stream

There are several strategies to create a more tax-efficient income stream, without necessarily taking on more risk. One strategy is to draw on your various income sources in a certain order, starting with less tax-advantaged sources such as GIC income in a taxable account. This gives tax-advantaged sources such as your RRIF more time to grow on a tax-deferred basis. Another strategy is to split your income with your spouse so that you have similar incomes and thus similar tax rates. Because of Canada’s marginal tax rates, a couple with two similar tax rates generally pays less combined tax than a couple with two different tax rates.

5. Enhance retirement income with special tax-advantaged plans for business owners

An Individual Pension Plan (IPP) allows business owners and incorporated professionals like dentists and vets to make larger tax-deductible contributions compared to an RRSP. A Retirement Compensation Arrangement (RCA) — sometimes called a “super-sized pension plan” because there are no set limits on contributions or benefits — is designed for owner/managers or key employees seeking supplementary retirement benefits.

6. Enhance your legacy the tax-smart way

Because of the potential for large taxes on your estate, the government could be your single largest beneficiary when your estate is settled. One way to deal with these potentially large taxes is through the use of insurance-based strategies, which cover the taxes, maximizing your legacy.

A. Craig Elder, CFP, FCSI, CLU, CHS is branch manager with RBC Wealth Management Dominion Securities Inc. in Medicine Hat. Advisors are insurance licensed under RBC Wealth Management Financial Services Inc., a subsidiary of RBC Dominion Securities and is part of the RBC Financial Group, member CIPF. For more information on this and other financial strategies contact an advisor 403-504-2700.

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