Our tax savings tips can help you get the most out of your return.
The biggest household expense for most families is income tax. You work hard for your money, but that doesn’t stop the taxman from collecting a considerable portion of it. You could see 30 percent or more of your income earned going towards income tax in any given year.
While most of us don’t enjoy paying taxes, we want to pay our fair share since taxes go towards important things like hospitals, police and highways. However, what if I told you there are legitimate ways to reduce your income tax bill?
We already discussed tax credits. In this article, we’ll focus on other legit ways to save on your tax return bill.
Saving for your child’s education
One of the best ways to save for your child’s post-secondary education is using the Registered Education Savings Plan (RESP). The RESP is a federally sponsored tax-sheltered investment plan. It helps you save for your child’s post-secondary education.
With an RESP, you’re able to contribute up to $50,000 for each beneficiary (i.e. your child). You can save on tax and help pay for your child’s education. Your contributions then grow tax-free inside the account until your daughter or son is ready to attend college or university.
When you open an RESP, not only are you setting up an account that will make it easier to save for your child’s future, you also may receive free money from the federal government.
When you contribute to the RESP, the government will match a portion of it. All in all, you’re eligible for a lifetime maximum of $7,200 per child in Canada Education Savings Grant (CESG). To make the most of your child’s RESP, aim to contribute $2,500 per year to receive the yearly maximum of $500 in CESG.
The easiest way to save money in your child’s RESP is to make it automatic. That means automatically contributing a preset amount from each paycheque, whatever your budget allows.
Depending on your family’s net income, you may be eligible for further grants. Also, don’t forget to apply for the Canada Learning Bond to benefit from tax-deferred supplements each year.
Encourage your children to contribute to their RESP with their own money. That way, they’ll value it more.
The government is happy when Canadians invest in the economy. Investing in the economy comes in many different forms. One popular way is by investing in financial investments. To help encourage more Canadians to invest, the government offers preferential tax treatment to certain types of investment income.
Interest income is probably the investment income you’re most familiar with. It’s when you put money in a savings or chequing account and earn interest. I hate to break it to you, but there aren’t any tax savings to be had on interest income (unless you hold it inside an RRSP or TFSA; more on that later). They tax interest income at your marginal tax rate (the tax rate you pay on your next dollar of income). You should probably think twice before holding all your investment funds in interest-bearing assets.
When you invest in mutual funds, exchange funds or stocks, and sell the underlying investment, that’s considered a capital gain. Capital gains are taxed in a particular way by the government, resulting in tax savings. When you sell the underlying investment, only 50 percent of the profits are taxable. Also, you aren’t required to pay income tax until you sell the investment. If you hold onto it for many years, you can benefit from the power of compound interest.
The third type of investment income is dividends. The taxation of dividends is a little more complicated than interest income and capital gains. I’m not going to go into the full details. It’s important to know that the taxation of dividends falls somewhere between interest income and capital gains in terms of preferential tax treatment.
While you may not be able to write off your credit card or mortgage interest come tax time, one type of interest you may be able to write off is the interest from an investment loan. That’s because any money borrowed to invest is tax-deductible in the eyes of the government. For example, if you have a Home Equity Line of Credit and you use it to buy investments, you can write off the interest.
However, before you decide to borrow to invest, it’s essential to make sure you understand the risks. When you borrow to invest, otherwise known as leverage, you have the potential to magnify your gains as well as your losses. If the investment goes south, not only could you lose your own money, you could lose the bank’s capital, so proceed with caution.
Tax-Free Savings Account (TFSA)
The TFSA is a registered tax-sheltered account for holding your investments. If you’re at least 18 years of age and you have a social insurance number, you’re able to open a TFSA.
Based on the name, it would be easy to assume that the TFSA is just a savings account (since it has “savings” in the name). While you can certainly holding savings inside your TFSA, you’re probably not getting the most out of your TFSA if you’re doing that.
To gain a better understanding of the TFSA, it helps to think of it as an investment bucket. You’re able to hold a garden variety of investment types in your TFSA, including mutual funds, exchange-traded funds, stocks, bonds, cash and more. Base The investments that you do decide to hold inside your TFSA should be based on your investment time horizon, risk tolerance and investor knowledge.)
The federal government introduced the TFSA a little over a decade ago in 2009 to help encourage more Canadians to save money. TFSA offers a lot of flexibility. You can use it for short-term savings goals like saving for a family vacation or long-term savings goals like retirement.
TFSAs work differently than traditional savings accounts in that you’re not required to pay income tax on any money you hold inside your TFSA. You won’t receive a tax refund on TFSA contributions like with an RRSP, although your TFSA contributions will grow tax-free over the years, helping you take advantage of compound interest.
Similar to other registered accounts, there is a maximum you can contribute to your TFSA. For example, in 2020, you could contribute $6,000 to your TFSA. Canadians who were eligible to contribute to the TFSA back in 2009 would have lifetime TFSA contribution limits of $69,500 as of January 1, 2020. (You’d have the contribution room even if you didn’t open a TFSA in 2009.)
If you don’t use this year’s contribution room, no worries. Any TFSA contribution room you don’t use in the current year can be carried forward to future years just like the RRSP. However, unlike the RRSP, any money withdrawn from the TFSA can be contributed the following calendar year again.
Be careful about keeping track of your contribution room. The Canada Revenue Agency (CRA) will send you your latest contribution room on your Notice of Assessment. However, you’re responsible for keeping track of it during the year. You’ll want to do that because you’ll face a steep one percent tax per month on any amount you over contribute.
Registered Retirement Savings Plans (RRSP)
An RRSP is a tax-sheltered account to hold your investments. Its primary purpose is to invest money you’ll eventually withdraw in your golden years. The government created the RRSP to help lower the tax bill of Canadians during their working years to help them save for retirement. Any money you contribute to your RRSP is tax-deductible in the current year.
Besides contributing to your RRSP, you can add to your partner’s RRSP (called a spousal RRSP). You can also contribute to a group RRSP at work if your employer offers one.
Speaking of contributions, how much you’re able to contribute to your RRSP depends on your earned income. You can contribute up to the lesser of 18 percent of your earned income or a maximum amount set by the government.
Wondering what your RRSP contribution room is? You can refer to your latest Notice of Assessment to find out. It’s important to note that if you enrolled in a workplace pension plan, the amount you can contribute to your RRSP decreases. This makes it a level playing field between the pension have’s, and the pension have not’s.
When you make RRSP contributions, it lowers your taxable income. If you want to get the most out of your RRSP, you could put it toward next year’s RRSP contributions. The tax savings you’ll get depend on your marginal tax rate. The higher your tax rate, the more you’ll save.
Contributing money to the RRSP doesn’t make sense for everyone. If you expect to have low income in retirement, it can actually be detrimental to contribute to an RRSP. That’s because it can result in the clawback of government benefits like Guaranteed Income Supplement and Old Age Security.
These are just a few of the many tax savings methods Canadians can get the most out of their 2020 Income Tax return. For more ways to save money and take advantage of the deductions and credits offered by the federal and provincial governments, Consolidated Credit has created the informative TAXES: Save Money, Solve Problems guide.