Plan ahead to lower your tax bill!

The tax rules in this country are in a constant state of change, making it difficult to know how to reduce the amount owing to Revenue Canada each year. The following tax tips apply to Canadians at or nearing retirement age. By planning ahead and implementing even a few of these suggestions, you should reap significant financial rewards by the time you’re ready to file your next return.

Reduce and defer taxes with an RRSPBy contributing to an RRSP, you not only lower the amount of taxes owing, the money in your plan grows on a tax-deferred basis. That means you only pay tax on the amounts you withdraw from the plan. If you are in the 40 per cent tax bracket and you put $3,000 in an RRSP, you will owe $1,200 less in taxes (40 per cent of $3,000).

Maximize your RRSP contributionsYou can put up to 18 per cent of your previous year’s earned income or salary into an RRSP, up to a maximum of $13,500. This amount will be lower if you already contribute to a pension or profit-sharing plan at work. Revenue Canada has made it a little easier to know how much you can contribute for the current year. That amount appears on the Notice of Assessment you rece after filing a tax return.

Consider a short-term loan to reach your maximum contributionMany banks and other lending institutions offer loans at prime or slightly higher, to help you reach your maximum RRSP contribution. Generally, if you can repay the borrowed funds within a year or so, or your income for the current year falls into a higher tax bracket then usual, borrowing funds for your RRSP contribution might make sense. But otherwise, the non-deductible interest that you will pay on the loan may negate the tax benefits of your contribution. Instead, consider making regular “catch-up” payments later, when you have the funds to contribute.

Understand the tax treatment of your investmentsSome investment products are taxed at higher levels than others. For example, dividends and capital gains are taxed at a lower amount than the interest earned from fixed income investments. If you are able to divide your investments into two pools — one inside and one outside of an RRSP — try to place the higher taxed investments inside the RRSP, where they will grow on a tax deferred basis.

Invest in securities that can grow tax-deferred Capital gains from stocks are not taxed until they are realized. Therefore, investing in such shares for the long term can become a form of tax deferral. In addition, you have control over the timing of the realization of the gain.

The lower-earning spouse should invest If the lower-earning spouse is the registered investor, any investment income will be taxed at their rate, or not at all if his or her income is low enough.

Save twice with a spousal RRSPIf one spouse is the main breadwinner, it pays to place a portion of his or her annual allowable contribution into an RRSP for the other spouse. This will not only lower the breadwinner’s taxable income, it will allow the RRSP money to be taxed at a lower rate when it is withdrawn by the other spouse. Remember, if your spouse withdraws the funds from the RRSP within three years after your latest contribution, the amount will attribute back to you and be taxed in your hands.

Practice income splitting with your spouse If your spouse is in a lower income bracket, your tax bill will be reduced if you transfer some of your taxable income to your spouse. “Income splitting” refers to the transfer of money or property from a higher-income spouse to a lower-income spouse who pays tax in a lower tax bracket. You should proceed carefully, since the “attribution rules” in the Income Tax Act prevent many forms of income splitting. For example, if you transfer or lend property or money to your spouse, any income or loss from the property will be attributed back to you for tax purposes.

There is an exception to the attribution rule, however. If you sell assets to your spouse for fair market value and you report the gain, the attribution rule will not apply. You can also lend money or property to you spouse, but to avoid the attribution rules, you must charge interest on the loan and report that income. The interest rate must be at least equal to Revenue Canada’s prescribed interest rate at the time. The interest must be paid each year, by January 30 of the following year. If the January 30 deadline ever passes without your spouse paying the interest, that year’s income and all future income from the loaned property will be attributed back to you.

Another way to increase the lower-income spouse’s investment base is to make sure that groceries, mortgage or rent payments, credit card bills and all other daily living expenses are paid by the higher income-earning spouse. This will allow the lower-income spouse to maintain a larger investment base for earning future income that is taxed at a lower rate. If you use this technique, you and your spouse should have separate bank accounts into which you deposit your income. Using separate accounts will allow you to keep records to show that the earnings of the higher income spouse were used to pay the expenses.

A third way to effectively transfer funds is for you to directly pay your spouse’s tax bill, both in April as well as any instalments that are due during the year. Make sure the cheque used to pay your spouse’s taxes is drawn on your own account. Any funds your spouse would otherwise use to pay taxes can be invested without the income being attributed back to you.

Transfer income to your children You can reduce your taxes by transferring part of your taxable income to children who earn little or no taxable income. Note: if you give investments to a child under 18, all interest and dividends will be attributed back to you and taxed accordingly. This attribution rule does not apply to capital gains or income earned on income. Income from loans to adult children will be attributed back to the lender under the attribution rules. If interest is charged and paid as discussed above, the attribution rules will not apply.

Registered Education Savings Plan (RESPs)Contributions to an RESP are NOT tax deductible. However, the income in the plan grows tax-free, so RESPs do enjoy the effect of tax-free compounding of interest. When your child (or grandchild or other child you choose as beneficiary of the plan) goes to college or university, the RESP provides an income to help cover the child’s tuition and living expenses. The income will be taxable to the child, who, will usually not have much other income and therefore will pay little or no tax.

Beginning in 1997, the maximum contribution to RESPs for all taxpayers is limited to $4,000 per year (up from $2,000 in 1996) and $42,000 lifetime in respect of any one beneficiary. In addition, the maximum period over which income generated in an RESP may be sheltered from tax is 26 years.

Family plans are subject to the same contribution limits per beneficiary, but if one of your children decides against post-secondary education, the funds you have contributed for this child and –- as of 1997 –- the income earned on those contributions, can be redirected to benefit your other children who do pursue post-secondary education.

If none of your children go on to post-secondary education by age 21, and the plan has been running for at least 10 years, you can transfer up to $40,000 of RESP income during your lifetime to your own or your spouse’s RRSP (to the extent you or your spouse has available contribution room). If you do not have enough contribution room to fully offset the RESP income, you will be subject to an extra charge of 20 per cent of the extra RESP income (plus an additional 10 per cent if you live in Quebec) on top of the regular taxes on the amount.

Ask the government to reduce the amount of withholding tax on a paychequeRevenue Canada may, at your request, reduce withholdings if you have contributed to an RRSP early in the year, made a significant charitable donation, paid out a large medical expense, incurred child care, alimony or child support expenses as these will lower your taxes payable.