The old saying goes, ‘people who complain about taxes can be divided into two groups: men and women.' As the April 30th tax filing deadline looms, we are all trying our hardest to pay as little tax as possible. So this time of year, it’s pretty common to find different experts sharing their top tax savings tips. Here’s my timeless rendition:
- Know your marginal tax rate. I’ve said it time and time again. Tax planning is the foundation for financial planning and it all starts by knowing how the tax system works. The root of every financial decision you need to make requires a basic understanding of our Marginal taxes. In Canada, we have four basic tax brackets. Any personal income up to $10,527 is tax free. From $20,527 to $41,544, you are in the 15% bracket. From $41,544 to $83,088 you are at a 22% marginal tax rate. Income from $83,088 to $128,800 is taxed at 26%. And finally, income greater than $128,800 is taxed at the highest marginal rate of 29%. On top of these rates, each province also has provincial tax. Here in Alberta, you can simply add another 10% to those rates. For example, if you earn $50,000 per year, you will pay 22% Federal tax and 10% provincial tax for a combined rate of 32%. Click here for more on the difference between marginal tax and average tax (an a link to my very popular tax rate card).
- Always think after-tax! Far too often, investors look at what I call ‘surface returns’. All things being equal, if fund A returned 10% and fund B returned 9%, you would take fund A over B – right? But consider that fund A returned 7% after tax and fund B returned 8% after tax. Now which fund would you choose? The focus on after-tax investing is long overdue. The higher the marginal rate, the more important it is to become a tax-smart investor. Avoid interest income. Look for investments that generate dividends, capital gains and other tax preferred investment income. Always look at what an investment earns after paying the tax! Remember, it’s not what you make that counts; it’s what you keep that matters most.
- Take advantage of tax deductions. A tax deduction is a claim to reduce your taxable income. The value of a deduction is equal to your marginal tax rate. For example, if you earn $50,000 per year and contribute to an RRSP. That RRSP deduction is worth 32% in tax savings. RRSPs are the most common strategy for tax deductions. While there is more and more publicity on why you should not buy an RRSP, they are still the cornerstone of effective tax and retirement planning. Other deductions include union and professional dues, child care expenses, moving expenses, support payments, and interest expense (for business or investing).
- Income Splitting. Income splitting refers to the strategy of moving income from one family member to another. If a couple makes a combined income of $70,000 per year, they will pay a lot less tax if each spouse claims $35,000 on their tax returns as opposed to just one spouse claiming the entire $70,000. Ideally you only want to do this if you are moving income from a higher marginal tax rate to a lower rate. Some of the most common income splitting strategies are utilizing spousal RRSPs, investing in the lower income earner’s name, buying RESPs, and for retirees splitting CPP or pension splitting.
I’ve heard many people say that only the rich have access to tax strategies. As you can see, I believe tax planning is for anyone and everyone. Plan ahead and plan to pay less tax.