Tax saving tips for investors

If you’re going to invest successfully outside a registered plan, you have to take taxes into account. If you don’t, you’ll end up paying governments hundred or even thousands of dollars more than necessary.

Although tax-wise investment planning may seem a daunting task, in reality a few simple steps undertaken in any given year can help you to accumulate more wealth over your lifetime. Here are some key considerations for investors:

1. Know your marginal tax bracket:
It’s the rate at which your next dollar of income will be taxed and it depends on four things:

  • Your overall level of income
  • How these earnings are classified
  • Your allowable deductions
  • Your eligibility for non-refundable tax credits. 

This year, this tip is especially important, with the introduction of major changes to tax calculations by the federal government for both Year 2000 and 2001.  In addition, many provinces have switched to TONI: Tax on Net Income calculations. 

Make sure you understand your marginal tax rate on all income sources: 

  • Employment
  • Pensions
  • Intest
  • Dividends
  • Capital gains

The latter category, is subject to potentially three income inclusion rates in the Year 2000, so be sure you carry forward and back the right information about your capital gains and losses.

2.  Understand how income source and marginal tax rates affect your after-tax yield: Once you know your marginal tax rates on the next dollar of various income sources, you’ll understand the importance of using tax deductions and credits in your tax planning activities. 

Remember that:

  • Tax deductions are used to reduce your taxable income
  • Federal non-refundable credits reduce the tax you must pay on taxable income.

3. Know your province of residence for tax purposes: As far as the Canada Customs and Revenue Agency is concerned, your province of residence is where you live on December 31st, even if you relocated there on December 30.

So, if you move to a province in which tax rates are lower, doing so before year-end would mean that your income for the whole year is taxed at those lower rates, and vice-versa.

Be aware that Canadians pay tax to both the federal and provincial governments and familiarize yourself with TONI. This calculates tax on taxable income and requires taxpayers to file a separate new schedule this year in several provinces. 

Next year, it is expected that all provinces will move to this new calculation system.  Be sure to know how this will affect your after tax yield and your installment payment requirements in the future.

4. Know tax-exempt income sources: All income is not taxed at the same rate. For example:

  • There are reduced marginal tax rates for income from dividends and capital gains.
  • Other income, like scholarships and fellowships, may qualify for an exemption on the first $3,000 of such income.
  • Only net-not gross income from self-employment (that is income after paying your business expenses) is taxed.
  • Certain income, such as life insurance policy proceeds and gains on your tax-exempt principal residence, are tax exempt altogether.

Knowing how different income sources are taxed helps investors make better decisions on asset and income diversification.

5. Use your RRSP to minimize your tax liability on investments: An RRSP is a solid tax-planning tool for all. Contributions to an RRSP generate a tax deduction for the contributors. So RRSP investments are made on an after tax-basis and anything you accumulate in the plan is tax sheltered, until it’s withdrawn and added to your taxable income for the year.

Outside of an RRSP, investments are made using after-tax income and subsequent earnings will be exposed to tax. Such earnings include interest, dividends or capital gains. They will be reported to the investor on a T5 or a T3 slip, if it exceeds $50 and is part of your taxable income.

To contribute to an RRSP, you must have earned income in a previous year. Income from passive sources such as investments and pensions doesn’t qualify. Specifically, you must have taxable income. For most people, this is income over $7,231 in 2000 plus any age amount left after the net income clawback or other deductions and credits.  Check on exact levels of personal amounts, tax brackets and clawback zones at the beginning of each year, when indexed personal amounts are announced.
As well, since 1997, you may no longer contribute to an RRSP if you turn 70 in the tax year.  If you have unused RRSP room from prior years (back to 1990) you may make a spousal RRSP contribution, provided your spouse is under age 70.

What you need to know for the Year 2000 and 2001, however, is that because of anticipated tax reductions in 2001, an RRSP contribution for the year 2000 will be worth marginally more than in 2001, all things being equal.  If you qualify to contribute don’t miss the opportunity to apply your tax savings to the Year 2000 first.

Evelyn Jacks is contributing editor of CARPNews FiftyPlus and President of The Jacks Institute, Canada’s leading trainer of tax professionals.