Top Tax Planning Strategies for Canadians

How to Minimize Tax as a High-Income Earner

Written by John Woodfield, Portfolio Manager, CIM® CFP®

A crucial aspect of financial planning that often gets overlooked is tax planning.

Understanding tax planning strategies in Canada can help you optimize your financial situation, reduce your tax liability, and secure your financial future. In this post, we'll explore some of the most important tax planning strategies for Canadians and Americans living in Canada, ranging from the basics to more advanced techniques.

TABLE OF CONTENTS

1. Essential Tax Planning Strategies in Canada
2. 3 Basic Tax Planning Strategies Everyone Can Use
3. Critical Tax Planning Strategies for High-Income Earners
4. How To Ensure You Don't Overpay Tax
5. Common Questions About Tax Planning Strategies Canada
6. Summary of Key Points
7. Next Steps

Top 12 Tax Planning Strategies for Canadians

Essential Tax Planning Strategies

1. Claim All Eligible Deductions and Credits

The first step in effective tax planning is to ensure you claim all the deductions and credits available. These may include deductions for childcare expenses, student loan interest, medical expenses, and various tax credits like the Child Benefit and the GST/HST Credit.

2. Contribute To Registered Retirement Savings Plans (RRSPs)

RRSPs are a popular tax planning tool for Canadians. You can deduct the amount contributed to your RRSPs each year from your taxable income. Also, your investments grow tax-free within the RRSP until you withdraw the funds.

3. Take Advantage of Tax-Free Savings Accounts (TFSAs)

Although contributions to a TFSA are not tax-deductible, the returns earned within the TFSA are tax-free. This includes capital gains and interest.

Tax Planning Strategies for High-Income Earners

4. Do Income Splitting

High-income earners can benefit from income-splitting strategies. Income splitting is the sharing of income with family members who may be in lower tax brackets. This can be achieved through spousal RRSPs, dividend splitting, and family trusts, among other methods.

5. Use the First-Time Home Buyers’ Credit

If you're a first-time homebuyer, you can take advantage of this tax credit designed to ease the financial burden of purchasing your first home. The First-Time Home Buyers’ Tax Credit (HBCT) can significantly reduce your tax liability.

6. Contribute To Registered Education Savings Plans (RESPs)

RESPs are a tax-efficient way to save for your child's education. Contributions are not tax-deductible, though the investment growth within the plan is tax-sheltered. Significant government grants can boost your savings.

Taxation of Investment Earnings

7. Understand the Taxation of Capital Gains

In Canada, only half of a capital gain is taxable. If you invest in company shares, property or other assets, you'll only pay tax on half of the profit when you sell.

8. Beware of the Luxury Tax

Canada has a luxury tax on purchases such as high-end cars, yachts, and private aircraft. Be aware of the tax implications when purchasing such items.

Advanced Tax Planning Strategies

9. Consider Using Individual Pension Plans (IPPs)

High-earning business owners and incorporated professionals can use IPPs to enhance their retirement savings while benefiting from significant tax deductions. These can be complex and expensive to set up but are well worth it in certain situations.

10. Take Advantage of Life Insurance

Certain life insurance policies offer tax advantages. They can be used for wealth transfer, estate planning, or to provide a tax-free income in retirement. This area is often overlooked or viewed as an expense rather than a planning tool.

11. Understand Cross-Border Tax Planning if You're a Dual Citizen

Understanding cross-border tax planning is essential when you have ties to other countries or are a dual citizen, to avoid double taxation and ensure compliance with tax laws in both jurisdictions. For example, you need to ensure that you’re using foreign tax credits correctly if you’re a U.S. person in Canada.

12. Do Your Estate Planning Carefully

Effective estate planning can minimize the tax burden on your heirs. Strategies such as creating trusts, gifting assets, and designating beneficiaries can play a role in your estate planning.

Related Post: How to Reduce Tax for High-Income Earners

3 Basic Tax Planning Strategies Everyone Can Use

1. Contribute to Registered Retirement Savings Plans (RRSPs)

• RRSPs are tax-advantaged savings accounts that help Canadians save for retirement. Contributions to RRSPs are tax-deductible. In other words, they reduce your taxable income for the year you contribute.
• The money you contribute to your RRSP grows tax-free until you withdraw it. Your withdrawals will typically be at a lower tax rate. RRSPs benefit from tax-deferred growth, and you potentially pay less tax in retirement.

2. Use Tax-Free Savings Accounts (TFSAs)
   • TFSAs allow you to save and invest money tax-free. Any income, capital gains, or interest earned within a TFSA is not taxed.
   • Unlike RRSPs, contributions to TFSAs are not tax-deductible. The benefit comes when you withdraw funds. You can withdraw money from your TFSA anytime without incurring tax consequences.

3. Take Advantage of Tax Credits and Deductions

• Canada offers various tax credits and deductions. These can include credits for expenses like tuition fees, medical expenses, charitable donations, and home energy improvements.
• Researching and understanding the tax credits and deductions available to you is important. Keeping organized records of eligible expenses is vital to reducing your tax burden.

Remember that tax strategies can vary depending on individual circumstances and financial goals, so it's advisable to consult with a tax professional or financial advisor to create a plan that suits your specific situation.

Critical Tax Planning Strategies for High-Income Earners

Income Splitting

High-income earners can benefit from sharing income with lower-income family members.

Spousal Registered Retirement Savings Plan (RRSP)

Consider using family trusts or gifting assets to adult children. It is important to be aware of the "attribution rules" and to consult with a tax advisor for guidance.

Maximizing RRSP Contributions

Contributing the maximum allowable amount to your RRSP reduces taxable income. You can carry forward any unused RRSP contribution room from previous years.

Utilizing Tax-Efficient Investments

Invest in tax-efficient assets like Canadian dividend-paying stocks (investments eligible for the Canadian dividend tax credit). You may consider tax-efficient investment vehicles like exchange-traded funds (ETFs) and tax-efficient mutual funds that minimize taxable distributions. This is especially true if you invest within a corporation.

Maximizing Tax Deductions

You should aim to maximize the deductions available. This includes claiming deductions for business expenses, rental properties, and investment-related expenses. You must keep thorough records of deductible expenses and consult with a tax professional to ensure compliance with tax laws.

Using Other Tax-Deferred Accounts

Registered Education Savings Plans (RESPs) and Registered Disability Savings Plans (RDSPs) are additional ways to diversify your tax-efficient investment and savings strategies if you have children.

Charitable Giving

Charitable donation is a great way to reduce taxable income since donations attract significant tax credits. Donor-advised funds (DAFs) can be useful for managing charitable giving while benefiting from immediate tax deductions. Insurance can also be used within Donor-Advised Funds.

Tax-Efficient Withdrawal Strategies

Make sure you plan your retirement withdrawals carefully. To minimize tax implications, you need a strategy for how and when to withdraw funds from various accounts, such as RRSPs, TFSAs, and non-registered investments.

Tax Planning With a Professional

Work with a tax advisor financial planner/Portfolio Manager who specializes in high-net-worth individuals and understands the intricacies of tax planning for high-income earners. It is important that your financial advisors are fiduciaries since they have a legal obligation to act in your best interests. This is especially important if you are a dual citizen.

Estate Planning

In many situations, an estate plan that takes advantage of estate freeze strategies, trusts, and gifting will minimize potential estate taxes and ensure wealth transfers according to your wishes.

Tax Efficient Compensation

Those who have control over their own compensation (e.g., business owners or executives) should consider structuring their income to maximize tax efficiency.

Tax planning for high-income individuals is complex and should align with your long-term financial goals. It's crucial to stay informed about tax law changes and regularly review your tax strategy to adapt to evolving circumstances.

Consulting with a qualified tax professional or financial advisor is essential.

How To Ensure You Don't Overpay Tax

Max Out Your RRSPs and TFSAs

To ensure that you don't overpay tax, make sure that you contribute to RRSPs and take advantage of TFSAs. While TFSAs won't reduce your taxable income now, they will allow you to withdraw taxable income when you're retired.

Use the First-Time Home Buyers’ Credit

Next, if you're a first-time home buyer who has acquired a qualifying home, you can claim a non-refundable tax credit of up to $750. The value of the HBTC is calculated by multiplying $5,000 by the lowest personal income tax rate (15 per cent in 2022).

Pay Attention to RESPs and Taxes

There are three types of withdrawals:

1 - Post-secondary education (PSE) withdrawals are the return of the contributions made to the RESP. There is no tax on this portion.

2 - Educational assistance payments (EAP) include government grants, the Canada Learning Bond (CLB), and investment earnings. These amounts are taxable to the beneficiary of the RESP. EAPs have a maximum of $8,000 ($4,000) for full-time or part-time studies during the first 13 consecutive weeks of enrollment. The limit does not apply after that time unless the student leaves their studies and doesn't re-enroll in a qualifying educational program (for 12 months).

Understand Taxation of Investment Earnings in Canada

In Canada, the taxation rate can vary based on the type of income and your overall income level. Understanding the tax implications of your investments is crucial for minimizing your tax liability.

Be Aware of Taxation of Capital Gains in Canada

Capital gains are profits from selling assets like stocks, real estate, or businesses. Only 50 per cent of capital gains in Canada are included in your taxable income.

Avoid the Luxury Tax in Canada

Luxury or excise taxes are imposed on high-end goods or services, such as luxury cars or jewelry.

Use Individual Pension Plans for Tax Savings in Canada

Individual Pension Plans (IPPs) are retirement savings vehicles designed for business owners and incorporated professionals. They offer enhanced retirement benefits and tax advantages over and above what is offered by traditional retirement plans.

Use Life Insurance for Tax Benefits in Canada

Life insurance serves many purposes in Canada. This includes providing financial security and tax benefits. Death benefits from a life insurance policy are usually tax-free, which makes it an essential component of estate planning for wealth preservation and tax minimization.

Understand Tax Risks in Canada

Navigating Canada's tax system is complex, and rules change. Understanding the potential tax risks and liabilities associated with your business, investments, and other ventures is crucial to avoid costly penalties and potential legal issues.

Get on Top of Cross-Border Tax Planning if You’re an American in Canada

Canadians and foreigners subject to Canadian taxes who have financial ties or assets in other countries can face complex tax issues. Cross-border tax and investment planning will help optimize your tax situation and ensure compliance with tax laws.

Be Sure To Do Your Estate Planning To Minimize Taxation

Strategies such as gifting, trusts, and estate freezes can be employed to reduce or defer estate taxes and ensure a smooth transfer of wealth.

Common Questions About Tax Planning Strategies in Canada

What are the main pillars of tax planning?

Tax planning generally consists of four main pillars: income planning, deductions and credits, investment planning, and estate planning. When you focus on strategically managing your income, optimizing deductions and credits, making tax-efficient investments, and planning to transfer wealth, you can minimize your overall tax liability.

What are some ways to avoid capital gains tax in Canada?

You can't entirely avoid capital gains tax in Canada, but there are strategies to minimize tax. Using tax-advantaged accounts like Tax-Free Savings Accounts (TFSAs) and Registered Retirement Savings Plans (RRSPs), offsetting capital gains with capital losses, and taking advantage of the principal residence exemption for your primary home are great options to start.

How can I reduce my taxable income in Canada?

This involves various strategies, including contributing to RRSPs, taking advantage of tax credits and deductions, splitting income with family members, and structuring your investments for tax efficiency.

What is the most tax-efficient investment in Canada?

Tax-efficient investments in Canada depend on individual circumstances. Investments that generate capital gains or Canadian dividends have favourable tax treatment. Tax-efficient vehicles like exchange-traded funds (ETFs) and tax-efficient mutual funds are also useful, especially for corporations.

How do high-income earners reduce taxes?

High-income earners employ many strategies to reduce taxes. These include maximizing RRSP contributions, income splitting, using tax-efficient investments, and exploring charitable giving for tax deductions.

How does income splitting work in Canada?

Income splitting is sharing income with lower-income family members to reduce the family tax burden. This can be achieved through strategies like contributing to a spouse's RRSP, using a spousal loan, or utilizing family trusts. Recent tax law changes have negatively impacted ways to income split.

How progressive is Canada's tax system?

A progressive tax system means that higher-income individuals pay a higher percentage of their income in taxes. The federal and provincial/territorial tax rates increase as income levels rise.

How do I avoid paying taxes on a large inheritance?

Inheritances are generally not taxable in Canada. The estate of the deceased individual is responsible for any applicable taxes. However, there may be taxes on income generated by inherited assets.

Where is the best place in Canada for taxes?

Some provinces have lower income tax rates or offer specific tax incentives. It depends on your circumstances, including income, investments, and lifestyle.

Summary of Key Points:

• Tax planning strategies allow you to keep more of your money. Consider strategies like maxing out your RRSPs, TFSAs, and income splitting.
• Effective estate planning, cross-border understanding, and claiming deductions reduce tax liabilities.
• IPPs offer business owners superior retirement benefits and tax advantages compared to traditional plans.
• Understanding Canada's tax intricacies, from estate planning to cross-border issues, is vital for optimal wealth management.
• You may wish to work with a fiduciary financial advisor who is legally obligated to create a financial plan and investment strategy that puts your best interests first.

Next Steps

If you’re a Canadian resident or are planning on moving to Canada and need assistance with moving and optimizing your investments, estate planning, wealth management and portfolio management, please get in touch. At SWAN Wealth, we specialize in Canadian financial planning, cross-border financial planning and cross-border wealth management.

Tax Planning Articles and Guides for Canadian Residents

If you’re planning a cross-border move, these articles and guides will help you simplify your move and ensure you’ve covered everything.

Foreign Tax Credits in Canada and the U.S.

Certified Financial Planner in Canada - Finding a Fiduciary

How to Reduce Taxes for High Income Earners in Canada

Is a 401(k) Taxable in Canada?

About the Author

John Woodfield is a Financial Management Advisor (FMA), a Chartered Investment Manager (CIM), and a Certified Financial Planner (CFP), and in 2007, was inducted as a Fellow of the Canadian Securities Institute (FCSI). As a portfolio manager and CFP®, he works with clients across Canada. John Woodfield’s clients are families, individuals and business owners who understand the importance of comprehensive wealth and investment plans driven by the lifestyle they want to lead.

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