There are numerous ways to save on taxes to help you meet your financial goals
When financial advisors talk about providing their clients with the best service, they always recommend that they include financial planning along with tax and estate planning.
We’ve recently done an investor resource on the reasons to do estate planning, even when you’re young, which you can read here. But, why do you need tax planning? How does it work? It’s good to know some of the rudiments, even if you opt to hire a tax specialist to minimize your income tax.
What is tax planning? Tax planning is the analysis of a financial situation or plan to ensure that all of the elements work together to allow you to pay the lowest tax possible and save more of your hard-earned money. It allows you to use various tax exemptions, deductions, and benefits to minimize how much tax you owe. It’s essential to an individual investor’s financial plan because the more you can reduce your tax liability, the more you can contribute to your other financial goals, such as paying down a house or saving for retirement or taking that dream vacation.
How is tax planning done? Tax planning considers the size and timing of income, timing of purchases, and planning for expenditures. It also includes selecting investments and the right type of retirement plan to complement your tax status and deductions to create the best possible outcome.
What are the benefits of tax planning? The whole idea of tax planning is to reduce the amount of income tax you pay so that you can save more for your retirement or other financial goals. If you can hire someone who is knowledgeable in the field, that person will be up to date on the law and changes to it, and how it applies to you and your particular situation. The more loopholes they can access, the more you will be able to save, so it’s important to consider getting help here.
What kind of tax planning strategies are there? There are many different strategies covering many areas. A good tax plan will allow you to use a variety of them. Some include:
- Registered Retirement Savings Plans (RRSPs): RRSP contributions can not only result in immediate tax savings, which you can claim as a deduction on your income tax, but help you grow the money in the fund. It is tax-free until you withdraw it, and then you have to pay the taxes on it, so it’s good to get professional advice here, too, to minimize that hit.
- Spousal RRSP: RRSPs also provide opportunities for income splitting with a spouse. They allow couples, where one person earns more than the other so is in a higher income tax bracket, to maximize their collective tax refund. It allows one spouse to contribute to the RRSP account on behalf of the other and thus gain a tax deduction, which keeps more of the money in the family.
- Income-splitting: The owner of a small business, for instance, can split income with a spouse by employing him or her in the business.
- Registered Education Savings Plans (RESPs): RESPs allow you to save for a child’s post-secondary education costs, but also receive some matching money from the government to grow the fund even faster. These also have annual limits and rules to follow, so check them.
- TFSAs: Tax Free Savings Accounts allow Canadians over 18 with a Social Insurance Number to save a specific limit of money annually in a fund without it being taxed. In 2022, the contribution limit was $6,000 with a lifetime contribution limit of $81,500. Unlike RRSPs, you can withdraw it tax-free at any time, though your financial institution may have a penalty.
- Tax gain-loss harvesting: You can also do tax gain-loss harvesting on your investments. That means you can use a portfolio’s losses to offset your overall capital gains. There are also rules on how you can do that, especially if you have short or long gains. So, ask your advisor or tax specialist for advice to ensure that you’re effectively maximizing this strategy.
Read the income types that qualified for income splitting in Canada here.
There are many different tax strategies, all of which have rules. So, ask your financial advisor or find a tax specialist who can help you create the best combination to ensure you keep as much of your income as you can to grow it toward meeting your goals.