Your taxes have been filed and you have received your tax return – now what?
There are several ways you can be proactive with your tax return, which means you will be “working smarter and not harder” for your savings. Here are a few ways to stretch your money further.
1. Invest in a Tax-Free Savings Account (TFSA)
Any Canadian who is 18 years or older with a valid social insurance number can contribute to a TFSA – this means you can have an early start on your financial planning. Keep in mind the annual contribution limits for 2016 has been rolled back to $5,500 from $10,000 in 2015.
Contributions to a TFSA are not deductible for income tax purposes. But any amount contributed as well as any income earned in the account (investment income and capital gains) is generally tax-free, even when withdrawn (CRA).
It’s important to keep this in mind, because knowing when to use your TFSA versus your RRSP for savings or withdrawals is key, especially near retirement because it can drastically impact how much tax you pay that year.
2. Make a contribution to your Registered Retirement Savings Plan (RRSP)
While the deadline to contribute to your RRSP for 2015 has passed, it’s never too early to start contributions to your RRSP for next year – as long as you have contribution room. You should always consider investing your tax return in an RRSP to grow your retirement savings.
Deductible RRSP contributions can be used to reduce your tax and any income you earn in the RRSP is exempt from tax as long as the funds remain in the plan – you typically have to pay tax when you receive payments from the plan.
Generally, one should refrain withdrawing from RRSPs before reaching the age 72, when it is then required to make mandatory withdrawals. When income levels are low, withdrawing from your RRSP could be advantageous because the tax payable would be low that year. But, in most cases clients should first draw from their TFSA and taxable accounts allowing other assets to continue to grow as long as possible.
3. Contribute to a Registered Education Savings Plan (RESP)
A large student debt can be financially crippling for a young person just starting their life, especially as it’s often compounded with the same time they are buying their first home, or thinking about starting a family. Start to squirrel away some savings early and take advantage of the tax benefits over time.
It’s always smart to plan ahead, not only for your own retirement but for your children’s education as well. You can either contribute to a family plan or a specified plan. There is no annual limit for RESP contributions, however, the lifetime limit on the amounts that can be contributed to all RESPs for a beneficiary is $50,000 (CRA).
Contributions are not tax-deductible, but all investment income generated in the RESP is tax-sheltered. Plus, the government may add up to $500 in contributions per year per child. And, when the money is withdrawn, the plan earnings and government contributions are taxed in the beneficiary’s hands – often students, with low income that would pay minimal or no taxes on the money.
4. Re-invest your money back into your portfolio
Many affluent investors use more than one investment firm, leading to a piecemeal approach, often resulting in higher tax bills. As written in our piece on tax efficiencies, investors should pay close attention to asset allocation, which is the process of placing particular investments in either taxable or tax advantaged accounts.
By putting an asset into an account that receives the best tax treatment, investors will likely be able to gain an additional return each year. While the yearly amount may seem minimal, after 30 years or more, the tax savings will add up and can boost retirement assets by as much as 30 per cent.
Start by shifting investments subject to the highest marginal tax rate. Tax advantaged accounts should be first populated with bonds. If there is additional room, high turnover, active equities should be put away in the tax benefit accounts. Ask questions and find out what the best options are for your assets.
There are many things to think about with hopefully a little extra cash flow coming your way soon. Speak to your financial advisor and review your options. Find out what works for you this year.