By Mark Doyle, CFA
Maximizing your retirement portfolio should begin with strategies to minimize tax. After all, a typical single-income family in Ontario, earning over $150,000 per year, has a marginal income tax rate is about 48%; it rises to 53.5% for income over $220,000. If you are able to reduce your taxable income by, say $10,000 per year, without reducing your gross income, you will be about $5,000 richer.
Although my expertise is investing (I am not a tax expert), tax awareness is critical to any financial or investing discussion. Here are some of my favourite tax-reduction strategies that I use and recommend to my clients:
TFSA or RESP?
If you have children, consider maximizing your contribution to a RESP. For a $2,500 contribution per child each year, the government will match $500. That is a 20% return on day one! This is the best deal going. Your kids will end up being taxed during post-secondary education, when they will likely pay little or no tax. If you don’t have kids, see RRSP vs. TFSA below.
RRSP or TFSA?
Both. But, if you can’t do both, likely best to contribute to your TFSA when your marginal tax rate is low, relative to your expected career average. Contribute to your RRSP when your tax rate is relatively high, especially vs. expected marginal rate at retirement, and don’t forget about any unused RRSP room.
RRSP or Mortgage?
Generally, if you expect your RRSP to earn more than your mortgage rate, you will probably be better off investing in your RRSP, rather than paying down your mortgage. To make this strategy pay off, you will need to take risk, and will likely need to invest in equities, which generally have a higher expected return than fixed income.
RRSP withdrawal… What??
Yes, an RRSP withdrawal! If you (or your spouse) have temporarily left the workforce (e.g. maternity leave) and that person’s income is unusually low or zero for the year, consider making a RRSP withdrawal. Given that the basic personal exemption is about $12,000, you could withdraw the same amount for each year that you are out of the workforce and pay no taxes (any tax withheld would be refunded). You received a tax-deduction when you contributed, but no payback on withdrawal. RRSPs are not just for retirement!
Retiring in the next few years?
Do some planning. There are several things you can do to keep taxes down. You can reduce any claw-back of OAS, which is taxable, by topping up your RRSP during retirement (before age 72). Take money from your TFSA, which is not taxable. You can delay OAS if income is too high, or draw down your RRSP prior to commencement of OAS i.e. take the tax hit before your OAS begins.
Home Mortgage – Make interest payments tax-deductible!
If you have a home mortgage, consider a restructure to make the interest tax deductible. Use taxable funds pay down your mortgage. Then use your home-equity line of credit and borrow an equal amount to invest back into the market. Your interest payments are now tax-deductible! Your loan rate will probably be slightly higher than the mortgage rate but you will still be better off, after tax.
Here is an excellent source for Canadian tax tips and financial calculators: TaxTips.ca. Add it to your favourites.
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The views expressed are general observations based on my experience. This commentary is provided for informational purposes only and does not constitute financial, investment, tax, legal or accounting advice. Individual circumstances vary and must be considered in any financial decision making. Anyone wishing to act on the ideas in this newsletter should consult your professional advisor.