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Thursday, April 24, 2014

Maxed Out

Posted by Tim Stobbs on April 9, 2014

While I was having coffee the other day with some co-workers it came out that I was maxed out…no, not on credit cards, but rather RRSP contribution room and last year my wife and I maxed out of TFSA contribution room.

Until that moment I had forgotten how unusual that state of being is for most people.  The older people around the table all had unused RRSP contribution room of $30,000 to $50,000 and all of them make an healthy salary.  So it wasn’t the fact they couldn’t save, but rather they had chosen not to.

In total Canadian’s have $600 billion in unused RRSP contribution room, which is a lot of tax savings people are leaving on the table. Put it another way, if everyone used that up in a single year at a mere 26% tax rate the government would be out $156 billion in revenue.  That doesn’t even touch the used TFSA contribution room out there as well.

So why is saving such a difficult thing to do?  After all the amounts aren’t huge in the case of RRSPs it is 18% of your previous year income (less pension adjustments).  So if you had a defined contribution pension you could likely get 5 to 10% there, which leaves anywhere from 13 to 8% left to be saved.  Yet you get a tax refund on that money, so as long as you keep putting your refund back into RRSPs you really only have to save around 10% or less.  Can you not live on 90% of your income?

Granted if you don’t have a pension plan this takes a bit more planning to really pull off.  18% of your income can seem a big difficult, but that is why you need to get the tax refund at once rather than waiting until tax season.  How? You can use that handy tax form T1213 Request to Reduce Tax Deductions at Source.  By having a regular contribution plan setup, you can fill this out and send it in then a few weeks later you can start getting your refund on each paycheck rather than waiting the full year.  This helps keep your cash flow up while saving.  The downside of this trick is you do have to file it every year (in most cases).

I should also point out I also had extra RRSP contribution room for a number of years (~$30k).  It was only between some planning and adding extra money for years that we managed to catch up.  Yet it can be done and when you put your mind to it.

So have you ever maxed out some contribution room?  If so, how did you do it?  If not, what is preventing you?

RRSP Over Contribution

Posted by Tim Stobbs on March 19, 2014

I finished a draft run on my taxes from last year for both my wife and I and realized I have a small problem.  I did much better on contributing to our RRSPs than I thought I did.

On the plus side I should be getting back over $4000 in a refund.  On the down side I believe I have burned through all my backlog of RRSP contribution room and then some.  At first I thought I was fine and then I realized if I claimed all the contribution in the first 60 days of this year on my 2013 taxes I would end up over contributing by just under $200 than my limit.

Now I have two potential solutions to this RRSP over contribution issue:

  1. Don’t claim $200 of RRSP contribution in 2013 and carry it for use in 2014 or
  2. Do nothing and realize I can over contribute by $2000 in an RRSP for a given year.

I had forgotten option #2 existed until I was reviewing some tax websites, so I tempted to just do nothing and take the refund.  After all it will balance out next year anyway.

In the longer term I now have to look at potentially doing something, but I’m not 100% sure I can.  I’m out of back contribution room in my RRSP, but my wife has about $20,000.  Yet she earns so little she doesn’t pay any income tax.  So I’m looking into if she contributes lets say $10,000 to her RRSP that would drive her income to zero and then does that trigger the transfer of her basic income deduction to me?  Thus giving us a tax savings at my marginal rate.  That is all in theory, I need to confirm we could do it.

Yet that plan would have a downside of introducing a zero income year on my wife’s CPP calculation.  Which would be fine if that occurs during a year when she could claim a child rearing provision to her CPP calculation, but otherwise may lower her CPP benefits in the long run. Ah choices in life.

So have you run into any odd situations with your income taxes this year?  If so, please share what it was and how you dealt with it.

The Wonderful World of Tax

Posted by Tim Stobbs on March 6, 2014

Oh dear, it’s that time of year again…tax season is upon us, and as our various tax related slips keep coming in the mail I’m getting ready to plug everything into some software and find out what we owe (hopefully) otherwise I just gave the government a interest free loan for the last year.

Yet during the last week I’ve had numerous tax related questions asked of me at work.  I’m not an expert by any stretch of the imagination, but I have developed a few rough rules to help people keep things straight in their head.

  1. Marginal Tax Rate Isn’t Average – People in Canada often like to complain about their marginal tax rate, or how much tax they pay on your last dollar of income.  Yet they can often confuse that with their average tax rate, which is the amount you pay overall on your income in percentage terms.  So people like to whine they pay a 39%  tax on their income, when in fact the average might be closer to 20%.
  2. Not all Income is Taxed the Same – Keep in mind the basic classes of income when you do things.  Interest income or profit from an unincorporated business is considered other income and gets taxed at your marginal tax rate (ie: the highest rate for you).  Meanwhile capital gains which you earn when you sell a stock in a taxable account for a profit is taxed at only half your marginal rate (like a permanent 50% off sale and keep in mind you only get taxed at profit part, your original investment is tax free).  Then finally you have dividend income which you get a big fat tax credit on, so even at higher incomes you often are taxed even lower than capital gains and for those at incomes less than $40,000 it can be close to tax free (at least from Canadian companies, US will be a be higher).
  3. Know Your Tax Shelters – RRSP are not an investment, they are a vessel for your investments that let’s it grow tax free.  So when you put money in your tax a refund of the taxes you paid on that income.  Yet you have to pay tax when you pull the money out, so your delaying the tax, not entirely avoiding it.  A TFSA is again a vessel, not a savings account.  Here you get no tax refund, but the growth again isn’t taxed, but the real bonus of this one is when you take money out you don’t pay a dime in tax.  Here you are avoiding tax.  So if you don’t know which to use, default to the TFSA first and for the love of god don’t just use it as a savings account for your next vacation, it’s a waste of a good tax shelter which could give you a tax free stream of income in retirement.
  4. Don’t Let Tax Savings Rule Your Investments – Obviously consider tax implications when investing, but a bigger issue is often the fees from your investments.  You pay fees every year on mutual funds, but if the money in in an RRSP you only pay the tax once when you take it out.  So a 1% difference in fees for 30 years are a bigger issue than which tax bracket you are in.  If the only reason you are going to buy an investment is tax reasons, it is usually a bad idea.
  5. Ask for Help – If you don’t know, go find some help.  I personally like the website TaxTips.ca as it is packed with useful information and I’ve yet to come across an error on the site.

So what tax questions do you hear about from others?  Any other common misunderstandings you hear about?