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Sunday, October 4, 2015

Tax, We Pay No Stinking Tax

Posted by Tim Stobbs on September 30, 2015

Of course the title of this post is misleading…of course I pay some tax right now…actually a LOT of tax when you get right down to it. Overall the number shifts around but in the end we pay about 20% income tax after using ever tax credit and deduction we can claim (based on total income for my wife and I – mine being almost all the taxes paid). So when it comes to retirement planning reducing your tax bill can go a very long way to shortening your retirement savings goals.  After all if you pay less tax in retirement you need to save less in advance to retire in the first place.  So how on earth do you keep your tax rate in retirement hovering around zero?  Well that are a few different ways to get close to zero in Canada, but to be honest a zero dollar tax bill is difficult to get down to.

The first one is likely the most straight forward and hard to do depending on your spending. Your basic income tax deduction allows you to pay no tax on the first $11,327 you earn for federal tax  in 2015 (I’m going to assume your provincial rate is equal to or higher than that number for this post, but please do check here).  So a couple can take in $22,654 in wages and/or RRSP withdrawals and pay no tax on it.  So if you are willing to keep to a low spending rate this gets fairly easy to do.  Just a note, yes you will pay a withholding tax on an RRSP withdrawal, but it will be refunded when you file taxes the following year if you stay below this limit. Oh, and please note…I’m not including Canada Pension Plan (CPP) deductions in this post since in my mind it isn’t a tax but rather a pension contribution.

Of course, even my spending budget is more than $22,654 so get more money out tax free you next stop will likely be the TFSA.  After all this account rocks, you put in after tax money and any growth you take out is tax free.  Nice deal, especially for young people who can potentially mainly skip the RRSP and put everything for their retirement dollars in this account.  Obviously the draw back here is for older folk who don’t have much savings in these accounts.  In our case, my wife and I plan to take out about $6000/year from these accounts during our retirement years.  So adding that to the basic deduction amount I can pull out $28,654/year tax free.

Yet that is still slightly short of our target spending of $30,000/year.  So am I out of tricks? Of course not, the last particular trick lies in the fact for lower income earners that you can often get dividend income completely tax free.  For example, if you clicked on that previous link and checked out Saskatchewan’s marginal tax rates you would have noticed for 2015 the tax rate for eligible dividend income is actually -0.03% for up to $44,028. Yes, the tax credit is actually worth just slightly more than the amount you get (hence the negative rate), so it is possible to get some eligible dividend income tax free.  The key here is to know what your particular province allows you to do.  For example, Ontario is even richer on the tax credit so while the limit is a bit lower at $40,922 but has a rate of -6.86%.  Nice eh?  Of course the downside is during your working career you will pay more taxes on this dividend income, but once you drop your income down in retirement you should be paying less.

Now the fine print…this works well in broad theory, but if you play a tax calculator (like these) you might find it doesn’t work out just perfectly.  After all if you have some working income during your semi-retirement years you may end up paying some Employment Insurance premiums and CPP contributions.  This also tends to break down when you get higher income levels.  So once you push past that eligible dividend limit you start paying more taxes.  Sorry, that are limits on how well you can play this game.

So have you tested your income plan to see how much tax you will be paying in retirement yet?  If not, I would suggest giving it a try.  It can be educational.  Or if you are retired how low did you get for your income tax bill?

Stop Blaming the Rich

Posted by Tim Stobbs on September 22, 2015

Okay, are you sick of this never ending federal election campaign in Canada?  Goodness knows I am already.  Yet perhaps the single thing that is pissing me off the most during this campaign is the idea of ‘let’s blame the rich’ theme. Or really more actually I’m not terribly impressed that a few of the proposals out there are to roll back the latest TFSA limit increase since ‘only the rich can use them’.

I okay with general idea of fairness.  After all no one likes to be screwed over in life and it does make entirely sense to me to have progress tax brackets that increase as income goes up.  After all if I am earning more I can easily pay a bit more to help out those that don’t earn much.  I don’t consider that unfair, but rather practical.

Yet rolling back the TFSA limit increase because only the rich can use is a damn crappy reason.  Um, news flash people…those how have built business, got high paying jobs and actually save some money to get rich…the system wasn’t fair to begin with.

For example, RRSP contributions are based on last years income up to 18% (to a given maximum), so the reality is that is actually worse for lower income people.  Since the more you earn beyond perhaps $40,000 a year it gets easier to save that amount.  Meanwhile the TFSA limit is equally to everyone over 18.  Even when it means the lower income people can potentially save a MUCH higher percentage of their income as compared to a person making $100,000/year.  Case in point the $10,000 limit of $40,000 is 25% of their income, which is WAY higher than the RRSP percentage.  Yet for the $100,000 income person the $10,000 TFSA limit is only 10%.

Then when we get to investment gains those that save also get some extra breaks, capital gains are only taxed at half of your marginal tax rate and Canadian dividends also benefit from a significant tax break.  The dividends are such a good break that if you earn less than $44,000/year they actually end up being tax free.

The system is built around encouraging people to save and invest, so those that do are rewarded by paying less tax.  Fairly simple right?  Yet it amazes me that people want to blame the rich.  Did you ever consider the fact the ‘rich’ may have started off just like you but rather than spend their money they decided to save it instead.  They learned a bit about investing and made ever more money.  It was often a hard long road, but after a number of years and the miracle of compound interest they are doing well.

Compared to those at my age and savings I’m likely considered rich or top 20% at least.  Yet the money just didn’t appear in my accounts in a puff of smoke…I got a degree and then a good job.  Then I saved for a decade straight likely spending less money than you did last year…that is why I have a net worth of over $750,000.  So go ahead and take away the TFSA limit increase for all I care…just stop blaming me for your problems and perhaps start to save something yourself.

The Tax Payoff

Posted by Tim Stobbs on April 29, 2015

So I managed to do a very good job of procrastinating on finishing my taxes this year and I only finished up during the weekend (but apparently due to an error by CRA you get until May 5 to get it in).  But now it is all done I’m just waiting for my over sized tax refund which pushed past $6000, which is good because my wife owed over a $1000.

You might be wondering why on earth I got such a big refund when I tend to avoid such things?  Simple a few minor shifts in the status quo of our taxes occurred:

  • The income splitting tax credit kicked in and we took full advantage of it.
  • I made a LOT of spousal RRSP contributions last year and now it is refund time.
  • My small business had a crappy year so I had very low profit to pay taxes on.
  • My wife on the other hand had a great year and so paid a bit more than usual.

Overall I tend to think all these minor tax credits and deductions are a bit of a pain in the butt.  I would much prefer a stripped down tax system which I could file on a double sided piece of paper.  Ironically, I found out I’m not alone in that thought according to a recent study.  We haven’t had a major overhaul in the system since 1987 and with all these minor credits you have to determine which of the 120 of them apply to you.  No wonder we buy software to do taxes now!

Ironically I think my procrastination had less to do with the taxes, but more to do with having to now deal with cleaning up all my files afterwards.  I normally use the end of my taxes as my trigger to do the annual clean up.  I just pull out old records and scan them where possible, shred old files that are no longer required and assess if I can make any improvements to my file system.  It’s not particularly fun work so I, like most people, tend to avoid it.

How are you doing with your taxes?  Are you planning to use the extra time or just get it over with?