How to tax plan efficiently with your investments and save for the future.
It’s usually a question that rolls around during the start of a new year, or after personal tax season is finished. What should I do with my excess cash and how do I save for the future?
While there are a number of ways to save money and invest, I have provided a general summary of the investment vehicles used to invest in the open market, and recommendations of how to use each of these from a tax perspective.
TFSA (Tax Free Savings Account)
Just like the name implies, all investments grow in a TFSA tax free. That is to say, when you cash in your investments, you do not pay any tax on accrued gains or interest earned. You also cannot report a loss if you lose money on your investments. The annual TFSA contribution limit for 2021 is $6,000. Therefore you can contribute this amount, in addition to your TFSA contribution carry forward room from previous years. If you withdraw from your TFSA, you do not permanently lose your contribution room. You can recontribute amounts you have drawn in the following year(s) and your contribution room carries forward indefinitely.
In most circumstances, it is recommended that individuals first max out their TFSA account in order to take advantage of the tax free growth. In a tax year where you know you will experience significantly higher income (e.g. capital gains from sale of shares, property etc.) than most tax years to follow, taking advantage of an RRSP that year may work to your advantage as I will explain below.
RRSP (Registered Retirement Savings Plan)
Unlike the TFSA, investments in an RRSP do not grow tax free. Investments in an RRSP are only taxed when funds are withdrawn. Although you can withdraw funds early, the idea is to leave the funds in until retirement. Unlike the TFSA, if you withdraw funds early, you permanently lose your contribution room. You cannot recontribute what you have withdrawn. An advantage to the RRSP over the TFSA is that any contributions (up to your deduction limit) made in the year are deductible against taxable income. The annual RRSP contribution limit for 2021 is the lesser of 18% of your earned income in the previous year, and $27,230. Your unused contribution limit from previous years carries forward.
A great time to take advantage of RRSP’s is when you currently earn taxable income in the lowest two tax brackets ($0 – $98,000) from stable sources, but you have one time income (e.g. a capital gain from a sale of a business, or property) that puts you into the highest tax ($315,000+) bracket for the tax year. Income taxed beyond 315k is at a rate of 48%, whereas income taxed between 0-98k is at a rate of 0-30.5%. Therefore depending on your contribution room, you may be able to contribute to an RRSP in that particular year, and reduce your taxable income and marginal tax rate. You will not only save tax on the reduction in income, but you will have also created an efficiency by moving into a lower marginal tax bracket. That is the beauty of the RRSP.
Non-registered Investments
Income from Non-registered investments are taxed in the year they are earned. There are no deductions to taxable income for any contributions made, however you may be able to claim losses on the sale of your investments. There is no annual contribution limit to a non-registered account. Therefore if you find yourself with a large sum of money and have already maxed out your TFSA and/or RRSP, you may be looking at a non-registered account as a means of investing the remaining funds.
Book a consultation with KENNEDY to learn more about how you can take advantage of your savings.
