Last updated June 7th 2023
Do you know what the number one impediment to building wealth is? Is it fluctuations in the market? Management fees? Inflation? Nope, it’s taxes, which is why it’s so important to be in the loop about your available options. Important reminder: always consult with a tax professional about your specific situation before implementing any unfamiliar tax strategies. Now of course everybody with earned income is required to pay taxes however there are some ways you can reduce taxes payable while not having to worry about the Canada Revenue Agency coming after you. There are a couple basic methods in the post but there are a bunch of novel ideas you may have not thought about. We will start off with a few basics.
Contribute to RSP
Investing in an RSP is one of the most foundational ways to reduce taxes owed in a given year. Any contributions you make in a calendar year or within 60 days of the following year can be used to reduce your taxable income. Let’s go through an example. Say you make $60,000 in 2023 and you put in $10,000 in your RSP throughout the year. It can be lump sum or multiple contributions during the year. In March or April of 2024 when you file your taxes for 2023, you can use the $10,000 to tell CRA, ok instead of taxing me on $60,000 worth of income, you can now only tax me on $50,000.
If you forget to contribute in 2023 you can still contribute funds up to February 29th 2024 or March 1st 2024 and still use those contributions for your 2023 tax year. Always confirm when the deadline is because it may shift due to weekends. CRA allows the additional 60 days to give you time to collect tax documents and get an idea of how much you may owe. Again, working with an accountant is recommended.
Just because you deposit funds in your RSP doesn’t mean it is mandatory to use the deduction in that year. In fact, the best strategy is to contribute when you are in a lower tax bracket, and deduct when you are in a higher tax bracket. Let’s walk through some numbers, purely for demonstration keeping in mind provincial tax rates vary. At $60,000 your overall tax rate might be 30%. If you get a new job making $90,000 per year your tax rate might be 40%. When you deduct in the 40% bracket you get 40 cents back for every dollar deducted where as making $60,000 you would only get 30 cents back. You can continuously dump funds into your RSP and wait to deduct them until you’re in a higher bracket.
Keep in mind the more you deduct in dollar figure your return will be more, but in percentage it will be less. Jumping back to our example you’re getting a 40% return until you deduct enough income to bring you into a lower tax bracket, which we assumed to be 30% and therefore your return in percentage would be a weighted average of the two brackets. There are maximums on how much you can contribute so don’t miss our dedicated RSP page.
Spousal RSPs have the same idea as personal/regular RSPs with a few tweaks. If you are married or a common-law couple and have a large gap between your incomes this is an account you should consider. Spouse A makes $100,000 annually while Spouse B makes $50,000. Spouse B can open up a Spousal RSP and Spouse A can contribute to that account.
The contribution limit is based on Spouse A’s room, but the funds now belong to Spouse B. Spouse A contributes $15,000 and if they choose to deduct against their income, now they’re taxable on $85,000 (or any number between that and $100,000). Spouse B now has $15,000 to grow in the Spousal RSP. When the time comes to use the Spousal RSP for income it would be taxable in Spouse B’s hands which would presumably be a lower rate.
One important caveat! Any withdrawals made within three calendar years is taxed back to the higher income earner. Spouse A contributes in 2023 and there is a withdrawal in 2024, 2025, or 2026 it will be taxed in their hands. If you contribute to a Spousal RSP, let it sit for at least three years. Another lesser known benefit that may or may not be relevant comes during conversion time. As mentioned in our Retirement Savings Plan page, RSPs need to be converted into Retirement Income Funds at age 71. If you are 71 and still wanting a tax reduction, if your spouse is under the age of 71 you can contribute to a Spousal RSP and still get the deduction.
Tax Loss Harvesting
Nobody wants to see a loss on their investments however there is a silver lining if the loss has occurred in a non-registered account. When investments are below the adjusted cost base you can realize the depreciation. Tax-loss harvesting involves voluntarily taking losses in order to create a current tax deduction to offset realized gains. Under performing investments that are not expected to recover in the near to medium term are candidates for tax-loss harvesting. Current holdings trading well above cost or previously realized gains, can be sold to provide the offsetting capital gains.
The CRA has restrictions on tax-loss harvesting trades through its superficial loss rules, which means that you can’t buy the same stock within 30 days before or after the loss trade. In addition, the capital loss can only be applied to the cost base of the original security. Be aware that the portfolio’s risk and return profile could change during the tax-loss harvesting process.
It’s possible you may be forced to wait the 30 day superficial loss period or if you cannot find good substitute securities that can also cause problems. The risks to the portfolio must be judged against the benefits of the tax losses. Transaction costs might be prohibitive relative to the benefits of harvesting. Transaction costs not only include the brokerage commissions, but also the effect on the bid/ask spread from the buy/sell orders. This becomes a significant cost as the portfolio’s size becomes smaller. The value of the tax deduction must meaningfully exceed the transaction costs before tax-loss harvesting should occur.
Finally, tax-loss harvesting should be put off if a portfolio’s losses are mounting, which is common during periods of lingering declines. This method loses its benefit if it is not applied right away. Keep in mind two things: 1) This technique only applies to non-registered accounts. 2) It is NOT mandatory to accept a loss, remember there are other factors to consider regarding your portfolio (asset allocation, risk tolerance, time horizon)
Crystallization, or managing unrealized gains, is similar to tax-loss harvesting, but takes the process one step further. After the selling trade is executed, the proceeds of the sale are used to purchase a stock that is in a gain position. This gaining security should be the portfolio holding with the largest unrealized gain or have the shortest expected holding period.
The effect of the purchase is to increase the adjusted cost basis (ACB) of the remaining stock. The unrealized gain is reduced and the future tax liability is lowered. Superficial loss rules do not apply here because the security that was repurchased was not the one originally sold. Crystallization maximizes the value of tax-loss harvesting by reinvesting the tax savings in the new security. For every $100 in losses an investor realizes, $100 multiplied by the capital gains rate in tax savings is generated. The idea is to use another security to compound the tax savings at a more favourable return.
Coordinate The Realization Of A Gain
Imagine you’re in a position where you don’t have any losses (lucky you) or you’re not ready to sell a losing security but you have a stock in a gain position. Consider what your income is like now versus the future. If you are not earning as much now as you will in the future it could make sense to realize the gain today. For example, are you on parental leave, off work due to injury, transitioning to a new job with a couple months gap, or planning to go back to school? These events typically coincide with lower income. If these events or something like retirement will be happening next year perhaps you want to delay realizing the gain until then.
Ok so you still have a security that has grown in value, well done, but you also have an altruistic itch you want to scratch. Donating stocks, ETFs, or mutual funds that have appreciated is a win-win scenario. If you have a stock with an ACB of $1,200 and current market value of $1,600, congratulations you have a gain of $400! If you have a worthy cause you are planning on donating to, rather than contributing cash you can donate the stock to the organization and bypass the $400 taxable gain. On top of that you get a donation receipt for $1,600 which can be used as a tax credit. Similar to tax-loss harvesting the donation must be from a non-registered account. There are certain criteria that must be met for the charitable organization to qualify so you can get the exemption.
Maximize Your TFSA
This seems like an obvious one but a lot of people overlook it. If you have built up investments or cash in a non-registered account and you don’t need the funds right away, move those funds into your TFSA. If the funds are sitting in cash there are no tax consequences. If they’re invested in securities you will trigger a tax event so be mindful of timing and amount of the gain or loss.
Alternatively if you participate in an Employee Share Plan wherein you get stock from the company you work for, see if there is an option to put the stock in a TFSA at your company. If not consider moving them to your TFSA either in-kind, which means as the existing stock, or sell the stock and use the opportunity to diversify your portfolio. As always be aware of the size and timing of your sale. You can confirm the amount you have available to contribute with CRA. Pro tip, CRA does not update in real time so remember any deposits you’ve already made this year. For a full refresher on TFSAs jump to this page.
The advantage of pension income splitting is that part of eligible pension can be shifted to the lower earning spouse, who would be taxed at a lower marginal tax rate. What type of income you can split depends on the age of the person collecting the pension
If you are under the age of 65:
• Pension income from a registered pension plan (RPP), for example, an employer-sponsored defined benefit or defined contribution plan (taxpayers must be age 65 or over for Quebec provincial tax purposes);
• Taxable portion of foreign pensions, including US social security;
• Income from an annuity, registered retirement income fund (RRIF), deferred profit sharing plan (DPSP) and variable pension benefits, as a result of the death of a spouse or common-law partner.
If you are age 65 and over
• Lifetime annuity payments from a registered pension plan (RPP),deferred profit sharing plan (DPSP), retirement compensation agreement (RCA);
• Payments from a registered retirement income fund (RRIF), life income fund (LIF), locked-in retirement income fund (LRIF), prescribed retirement income fund (PRIF);
• Interest from a non-registered life annuity and a guaranteed interest contract (GIC) provided by an insurance company;
• Taxable portion of foreign pensions, including US social security.
The CPP (Canada Pension Plan)/QPP (Quebec Pension Plan) program allows married or common-law couples to share CPP/QPP credits earned during their contributory period based on the number of years they lived together. This allows the couple to balance CPP/QPP payments if there is a difference in their individual pensions and may result in tax savings.
Maximize Credits and Deductions
We’re not going to go in depth on all the tax credits and deductions you have available to you for two reasons: 1) it is beyond the scope of this article and 2) there are many, many qualifications to earn them. We will list a few of the more common ones to give you a start. In terms of tax credits: charitable donations, Canada child benefit, GST/HST Credit, Canada caregiver credit, disability tax credit, tuition tax credit. Looking at common deductions we have: student loan interest, union dues, RSP contributions, fees paid for investment management, moving expenses, child care, for commissioned employee you have vehicle expenses, home office expenses, and advertising. There are a bunch more so spend some to researching and use what you can.
Use Income On Income
These next two techniques are advance so they may not be for everyone. In general, when the higher income spouse gives money to the lower income earning spouse and the funds are used for investment purposes, the income generated attributes back to the higher earning spouse. However, if the income is re-invested, subsequent income generated (“second generation income”) does not attribute back to the higher income spouse.
An example will help illustrate this method. Again we’ll assume Spouse A is our higher income earner. Spouse A gives Spouse B $10,000 to invest. That $10,000 generated $500 in dividends for the year. The $500 is taxed at A’s marginal rate. It is recommended that the income that is re-invested be invested in a separate account so that the second generation income is easily trackable. B takes that $500 investing it in a stock, the stock grows to $600 in two years and is sold realizing a capital gain. The $100 gain is taxed at B’s marginal rate. As this process continues the tax savings are compounded.
Ok so admittedly this technique works a lot better when interest rates are low so at the time of writing it might not make sense given the current rate environment. The rate of interest that is prescribed by the regulations in the Income Tax Act is updated as interest rates change so be sure to review the CRA website so you’re aware of the current rate. Loans made at this rate of interest between related persons are not subject to the attribution rules; therefore, where an investment is expected to produce a return that is in excess of this rate, it may be worthwhile for the higher income spouse to loan money to the lower income spouse and charge the prescribed rate of interest every year to avoid the application of the attribution rules.
If Spouse A charges less than the prescribed rate to Spouse B, attribution rules will apply to A. The yield from the money invested (over the amount of interest charged) will then be included in the lower income spouse’s income and taxed to him or her without triggering the attribution rules. If the prescribed rate is 5% and Spouse B earns 8% on their investment then 3% of the gain is taxed to Spouse B. There is no limit on the prescribed rate loan amount or the length of time the prescribed rate loan is in place, as long as any interest which is due and payable is paid annually on or before January 30th of the following year.