Over the past few years, I would have to say that my fiscal and political views have definitely taken on a more libertarian flavour.  I see waste and inefficiency in government that just makes me angry.  We have people in office that don’t seem to understand (in my opinion) that running deficit budgets for years at a time is probably not the best way to do things, especially since they leave the repayment of the accumulated debt to the next generation or next party to get into office who starts the whole thing over again…..

But I digress (please read the disclaimer  on the bottom far right sidebar, my views probably don’t reflect Tim’s at all, who owns the blog) even though I don’t agree with how most of the revenue is brought in, I will not (purposefully, I may by accident) cheat on my taxes.  In the several taxation courses I have taken on-route to a CGA designation, I have realized that it really just isn’t worth it.

There are many, many ways that an individual can cheat on their taxes – they can decrease their level of income, Increase the amount of expenses claimed, a person can hold onto money that should have been remitted as sales tax, or claim credits that they shouldn’t have.  An interesting site (if you’re into that kind of thing) to read about tax convictions on Canada Revenue Agency’s convictions page,which gives details of larger convictions and the reasons why they occurred.

I have come to realize that if I wish to live in this country (which I do), I need follow the tax laws as prescribed.  It’s not something I enjoy doing by any means, but rather then grumble about it, or try to cheat to get around paying them, I attempt to pay what I’m supposed to and keep good enough records that if I’m questioned on anything I would be able to explain what I did.  I never want to be in a situation where I have the CRA auditing me over my past 5 year’s worth of filings and knowing that I owe a substantial amount of money.  From a personal finance perspective, this would probably clean out my savings and set back my plans significantly, which is far from ideal.

What I don’t think most people realize (especially those cheating on their taxes) is that they have a choice – if they don’t agree with how things are working here, they can go somewhere else with a more favourable system.  Most people will not, and will continue to grumble and cheat and then wonder why they have to pay $84,547 in taxes and penalties (an example from the CRA site).  I know of several people who actively sneer at the government and continuously cheat on their taxes – I just wouldn’t want to take the risk a few years down the road via a random audit.  I figure if they don’t like the way things are running here, nobody is forcing these cheaters to stay in Canada.

What’s your stance on taxes?  How do you try to minimize the amount paid?  Would you consider moving due to your country’s taxes?

Well that is going to be easy.  Keep my nose out of it.  I don’t have a clue what the other parties will be offering in an election platform, so there isn’t much point worrying about comparing something to nothing for now.  Instead I will point out an important piece of advice…if you don’t like how things are going, go vote.  If you don’t understand something, find out and then go vote.  If you don’t like any of the options, pick your least offensive and go vote.  Why?

Because in a democracy a vote is basically your only weapon of choice.  It’s a one chance every four years once in awhile to voice what matters most to you.  Do you favour tax cuts to corporations or social programs or debt reduction?  Have your say and remember to vote.  Now I will put my little soap box back in the corner of the room.

Well actually the answer is a bit more simple that that.  At the start of each year I do a quick estimate of what my wife and I should make and then adjust my TD1 forms at work if required.  I generally aim for us to have a $0 tax refund when I do the estimate as such when we owe money that means we earned more together than we expected.  So the $2000 owing between the two of us means we earned roughly $5000 more than my original estimate (a combination of investment and business income).

So the tax bill in my view point is a good thing since I haven’t been giving the government an interest free loan for the last calendar year.  Instead I’ve been using that money for the last year to either invest or pay of some mortgage.  The trick I’ve noticed is you have to keep the amount owing reasonable and be prepared to pay if you suspect that you are doing better than you initially guessed.  The potential pitfall of this method is you don’t want to get your guess too far off from your income.  Why?  Well because if you are consistently owning more than $3000/year in taxes you will end up having to pay the government tax in installments (see here for information).

In the end I will now likely go back and adjust my TD1 forms for 2011 to have a little bit more tax taken off or another alternative would be to contribute more to an RRSP.  Either method would work depending on what your goals are and what your free cash flow is.  Also remember these are you last few days for an RRSP contribution so if you want to make a lump sum now for your 2010 taxes you still have time.

I like to joke that I don’t understand why no one checks with me before developing public policy. In reality, if I want my ideas to become a part of the conversation, I need to publicly join the discussion. I understand that it’s easy to criticize the government’s policy, but creating public policy is complex. The needs of all citizens should be accounted for, and it needs to be presented in a way that is politically palatable. Let’s look at the philosophy and values behind retirement and pension reform.

Where does our feeling that we are entitled to retire come from? A couple hundred years ago, entire families would do hard manual labour, such as on a farm or in coal mines and life expectancy was around 35 years old. If children survived to adulthood, they could expect to live to age 65 on average. In a predominantly agrarian or industrial society, workers were considered unable to contribute if they survived to age 65. A pension would retire them from the factory floor and pay them as long as they survived, probably at most 5 years. Today, with advances in public health, life expectancy from birth is around 67, although adults can expect to live well into their 80s. Further, our economy has shifted from agrarian and industrial to knowledge-based. The physical demands on knowledge workers are not comparable, besides which their expertise increases with age.

There is no real physical need for most people to retire. In an agrarian society, most children begin working quite young. Retirement is unlikely in such a society, so let’s suppose that over 65 years of life, 57 of those are spent working for a ratio of 88%. Today, public and higher education account for the first 22 years, with children seldom working during this time. Assuming a person works to age 65, then retires for a further 20 years, the ratio of working years becomes just 53%. Because people are able to be productive longer, due to work that is less physically taxing, and because people are living longer, retirement must not be mandatory. I think this is already the case, in most of the country.

We want to retire, but this is a preference, not a need. Who should provide this retirement? In the past, employers have provided it, in order to remove physically unable workers. Today, workers are living longer and pensions are underfunded. Retirement savings should be a personal decision. But employers are ideally situated to withhold savings from paycheques. The government has taken advantage of this in instituting CPP. Why is the government involved? Elderly citizens, some of whom are unable to work or who have no experience working, should not be allowed to live in poverty. Having a minimal pension scheme provides assistance to these valuable members of our society.

When a public pension system was originally envisioned, Old Age Security was instituted as a temporary measure until CPP began functioning. As with many government programs, the political will didn’t exist to end the temporary measure. One of the benefits of OAS is that it is means-tested, meaning that people who are over age 65 and have more than $70,000 income receive only a reduced benefit. Since CPP is conceived as a forced saving pension benefit, it should be fully funded. It is currently near 20% funded, with a goal of reaching 30% funding by 2075. This benefits current recipients at the expense of future recipients.

My preferred solution would be to immediately shift the payments of benefits from CPP to OAS. Current savers should expect to receive their entire CPP benefit from a fully funded public pension at retirement age. Current recipients, however, should receive a larger proportion of their income from OAS (which is means-tested) instead of CPP, especially given that the total contribution was under 4% for many years. Assuming the maximum entitlement, instead of receiving $517 from OAS and $960 from CPP, current pensioners would receive $1285 from OAS and $192 from CPP. More of the money would be subject to clawback, meaning that it would once again become a safety net for elderly Canadians. Once CPP is fully funded, it will provide a greater proportion of government retirement benefits and it will be more secure.

Because only working Canadians are entitled to CPP, but all Canadians who lived in Canada at least 40 years are entitled to OAS at age 65, some modifications would need to be made. A couple where only one spouse worked (2 OAS + 1 CPP) would receive a larger entitlement ($2762 vs. $1994). At the death of one spouse, OAS ends, whereas CPP pays a 60% pension to the surviving spouse ($1400 vs. $1093). Whether or not this would require a greater public expense depends on the income of Canadians over 65 (the age OAS begins). This could be addressed either by reducing OAS or by increasing the retirement age, possibly to 67, and also allowing people to begin CPP as early or as late as they choose.

CPP should maintain the mandatory component, but could add an optional component. This way, 9.9% of each paycheque, up to $4700 per year (currently), would be saved toward retirement. If a worker chooses, they could have an additional amount, possibly 9.9% of each paycheque beyond the current maximum, also saved for their account. In this way, they would either have a larger retirement benefit or an earlier retirement date. Because of the increased fund size, larger provinces, BC, AB, ON, should set up their own provincial pension plan, the way Quebec has.

For healthy people, retirement is not a right. It is a preference that must be planned for and prepared individually. It is helpful that we have CPP to provide forced savings, but it is unsustainable in its current form. OAS is a program that provides for seniors with only moderate income. Shifting the benefits from CPP to OAS would allow CPP to become sustainable and OAS to be modified as conditions require. How would you react to a government proposal of this type? Would you write your MP to endorse it?

Let’s begin by looking at how much is saved each year on your behalf. The total contribution, employer + employee, is 9.9% of your pensionable income (maximum of about $47,200). That is an increase from 3.6% in 1985. For 2010, the maximum contribution (for anyone earning over $47,200) is $4672.80 (for self-employed people, or split equally between employer and employee). Benefits are calculated based on 25% of average pensionable earnings, so for this example we will assume that the maximum was saved each year.

For the purpose of this example, let’s assume an individual graduates from university at age 22 and begins working with an income of $47,200 (or more) and maintains at least this level of earnings over their career. They retire at age 65, having worked for 43 years. We will use constant dollars, ignoring the effect of inflation since benefits are adjusted for inflation. This means that the 22 year-old graduate will contribute, either personally or from the employer, $4627.80 each year for 23 years. The total contributions will be $107,474.40.

The resulting amount of capital, $107,474.40, includes no investment return. To see what rate of return is implied by CPP benefits, let’s look at the current cost of annuities. (Disclaimer: this uses data for a female, whereas an annuity for a male at the same age would cost less, implying a lower return from CPP.) At age 65, a woman can expect an annuity to pay out interest and capital at a rate of about 6.84% per year. This will last to the end of her life, with no value at death. In this way, it works exactly like CPP. At age 65, the maximum CPP benefit is $960.00 per month. This is the amount of the benefit that would be earned in the example given above. In order to buy an annuity with a similar benefit, assuming a 6.84% payout rate, would cost $168,421. An indexed income, which CPP provides, would cost somewhat more than this.

Now it’s time to complete a future value of money calculation. Saving $4627.80 each year over 23 years and finishing with $168,421 implies a rate of return of 3.95% per year compounded. Add to this the fact that CPP may be around 20% funded, with the goal of being 30% funded by 2075. The fact that the fund is transitioning from pay-as-you-go (ie. current workers pay for current retirees) to a hybrid structure (ie. partly funded by current workers saving for their own future benefits) explains the low rate of return. The difference between this and the expected (market) return is what increases the funding level and the stability of the plan.

Personally, I expect not to rely on CPP. I can get a better return than 3.95% and I can take responsibility to save for my own retirement. And it’s a good thing, since I won’t even have the option of paying into CPP if I have no earned income. When I retire early and begin to rely on investment income (or move abroad), my contributions to CPP will end and my expected benefit at age 65 will stop increasing. People who are self-employed also have this option. If they take their income as dividends instead of salary, they don’t contribute to CPP and are wholly responsible for their own savings.

I don’t believe CPP is a bad idea. It provides a minimum income so that elderly Canadians are less likely to live in poverty. A couple who receives maximum CPP for a single spouse and OAS for each spouse should receive around $2000 per month. But it doesn’t mean we should expand CPP. It provides only a safety net and, as was mentioned in the comments to Tim’s prior post, different people prepare themselves in different ways. Who am I to say that choosing to reduce your spending, choosing to move to a lower cost country or choosing to reverse mortgage your house aren’t equally valid ways to deal with the need for income in retirement.

How do you feel about CPP? Do you appreciate the safety net it provides? Should people be forced to save more? Is it the government’s place to help us retire?

1. Determine what you should be paying in tax.  The problem with two jobs is they both only assume you have just one job.  So at least one of your jobs should be taxed at your marginal tax rate (for example 35%) while typically your employer is only taking off the lower tax rate (for example 26%).  That leaves you holding a tax bill for the missing 9% (35%-26%).  To find out your tax rates just head over to Taxtips.ca and find your province.  You just look up your rate for both jobs as a single job and add them together to find your marginal tax rate.
2. Pay more tax during the year? A common solution to knowing you are going to have a higher tax bill is to fill out at TD1 form at one employer to have the additional tax deducted.  This way you make sure you are paying the missing 9% or what ever you owe.  The problem with this method is you are assuming that you will just pay the tax bill instead of looking at a different option.
3. Avoid the tax bill entirely.  Another solution is the save your extra ‘tax owing; money into an RRSP if you have the contribution room.  That way you are building some savings and creating a tax break to offset your extra tax bill.  This becomes a little easier to save since you can use the very money you would owe in tax to fund the RRSP.

I’m personally have two jobs this year and I’ve decided to skip #2 and instead I’m using #3.  The great thing about this option is it allows you a larger free cash flow during the year to do what you want.  For example, for the first half of the year I paid down my mortgage a bit faster and for the last three cheques of the year I’ll be putting the extra money into my RRSP to reduce my tax bill.

This solution seem nice until you realize that getting an accurate estimate of your tax owing can be a little complex as you add in a few extra complications like: investment income, income from a small business, determining your EI and CPP over payment (since they are getting deducted twice) and then any other tax credits you qualify for.  Basically to do it right you would have to do your taxes twice: once as an estimate and then again when you file.  I’ve decided to skip the detailed estimate and use a rough one.  I might be wrong, but I should at least be close.

If you have two jobs or multiple income sources, how to you plan for your taxes?

I think perhaps people lost sight that this is a savings account and the government what’s to keep people from trying to use it as a chequing account.  They want you to save, not just for next week, but rather next year or longer.  Hence the odd rules.  To be fair about this situation,  the rules were not all that well explained when these new accounts were introduced.

I don’t think I even understood them exactly.  In my case I just screwed up my math and ended up over contributing by $10 to my TFSA because I didn’t check the amount of my last contribution.  I realized this after about two months and then took the over contribution out.  So my tax penalty is a whole $10 x 1% x 2 months = $0.20, so needless to say I’ve not received a letter from the government as the postage they use on the letter would cost more than what I ‘owe’.

Yet what I found particularly interesting was on my notice of assessment it showed my 2010 contribution limit to be $5010.  So if I understand it correctly then my over contribution actually resulted in me gaining contribution room the next year  (actually this was my fault I realized later on…I took out $20, not $10 to fix my overcontribution).  Obviously this just sounds wrong, since if this is correct you should in theory you could ‘buy’ extra contribution room.  For example, you over contribute by $5000 in Nov, then take out the excess in Dec.  Pay your $50 penalty and end up with an extra $5000 in contribution room the following year.

So after reading a little on the government’s TFSA site I think I understand why my $5000 example won’t work.  If you deliberately over contribute to your TFSA, you will likely trigger the ‘advantage’ clause and get nailed with losing that extra contribution room.  Yet based on my own experience there is some grey area, so I wondering if anyone else generated extra contribution room from their ‘screw up’?  If so, how much?  I’m curious to see if there is a set limit or not.

Many people who are aiming for early retirement are planning on using dividends to at least partially replace income previously earned through employment.  I think most people know that investing in Canadian public companies gives the benefit of dividend tax credits, and today I thought I would explain why there are dividend tax credits and how these credits fit in with the Canadian tax system.

The dividend tax credit system is set up to eliminate the potential of double taxation of investment income.  Without special tax rules, dividends would be taxed once at the corporate level and then again at the shareholder level when dividends are paid.  Although this would be ideal in the current economic climate (our government would end up with more tax dollars, which is something they are searching for at the moment) it is not all that equitable to businesses and individuals, hence Canada’s integrated tax system.

The best way to explain this premise I think is an example.  For this theoretical example, I’ve simplified some of the information, but it should provide an explanation of what I’m talking about.

A corporation earns $100, of which all after tax dollars are to be allocated to dividends.  The gross-up rate being used in the example is 1.45, which is the rate used on active publicly-traded corporations for last year.  The tax credit calculated is 31%, which is what was applied in British Columbia for 2009:

Federal Tax rate on $100               19.50

Provincial tax on $100                     11.50

Total                                                      31.00

Dividend Available                           69.00

Grossed up at 1.45*                        100.00

Dividend tax credit                          31.00

So, essentially what the dividend tax credit ensures is that the $31.00 already collected by the Canada Revenue Agency is not collected on again.  Dividend income itself is taxed on the individual, but if you follow the math, the individual would have a credit from the $69.00 received and would only be taxed on $38.00 of dividend income in this simplified example.

The dividend tax credit is only available to Canadian dividends. The Canada Revenue Agency really doesn’t care if they’re double taxing you on foreign dividends, as another government received the benefit of the corporate portion ($31.00 from the example above).   The ramification of this double taxation means that other than allowing your portfolio to become more diversified on a currency basis, you lose out if you’re investing in a foreign company if there is a comparable domestic stock that could be bought.

The dividend tax credit also makes it much more beneficial (tax-wise) compared to other sources of income (such as interest) which don’t have similar credits available.

Of note, dividend credit is going to be decreasing over the next few years, as corporate taxes are declining and in order to match the lower amount of taxes being paid by corporations, shareholders will get less as a credit.  The following amounts show the federal dividend tax credit amounts on dividends paid from a public corporation in Canada (provincial amounts vary across the country).

2009 = 27.5%

2010 = 25.88%

2011 = 24.12%

After 2011 = 22.35%

So, I hope I have provided some information as to why we have a dividend tax credit and the overall implications of the credit on the Canadian tax system.  Any questions?

You have to realize that I’m used to my wife owing a little bit of CPP each year, but I’m in a bit of a surprise that I personally own anything.  I’ve been on refunds for such a long time that I’m having some difficultly adjusting, since I usually leave a bit of cushion on my tax planning to make sure I have a small refund.  Yet in hindsight this isn’t surprising at all for a few reasons.

1. Second Job – It’s just about impossible when taking a second job to have the right amount of tax coming off at the start, unless you are very good at calculating the tax implications of that additional income.  I’m not that good, I always seem to be off a bit.
2. Selling some stocks – Upon opening our TFSA’s in 2009 we sold off some stocks in our taxable accounts which triggered capital gains/losses.
3. Home Buyers Plan – When I did my tax planning I messed up a little bit and forgot about my home buyers plan repayment, which is about $700.

All in all it’s not much that I owe, about $300 right now.  So from a tax planning side I did fairly well, I’m just off a little bit from owing/refund goal of $0.  A reminder the deadline to file is April 30 in Canada.

So how did you do on your taxes this year?  Are you having  a refund or do you owe?

Overall the  numbers will looks something like this (rate per $100 of earnings):

• 2010/11 – $1.73
• 2011/12 – $1.88
• 2012/13 – $2.03
• 2013/14 – $2.18
• 2014/15 – $2.33

So we are looking roughly at a 35% increase over the next four years and this according to our government is not a tax but rather a premium increase.  Which since it looks like my total EI deduction will easily be in excess of $1000/year when the current maximum is just under $750 doesn’t provide much comfort for me.  For employers, by the way, the matching rate is just 1.4 times the above numbers.

Overall expect to pay more for EI for many years to come.  The only good news in the longer term is if unemployment goes down we should see those premiums come back down by 2017 or so.  So at least I should see some lower rates before I plan to retire in 2023, I hope at least.