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Tuesday, March 3, 2015

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 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?


Under the Hood of My TFSA

Posted by Tim Stobbs on October 7, 2013

During my last net worth update I commented on the fact my Tax Free Savings Account (TFSA) contributions are now maxed out which would mean I’ve contributed $25,500 in the last five years.  That account balance at that time was $33,100 or a total gain of $7600 or 30%.  The gains are big, but you have to keep in mind that my TFSA is my highest risk account.  Unlike a lot of people who just put their contributions in savings account (paying 1% return which is so tragic waste of this accounts potential I almost weep when I hear it), mine is all invested in individual stocks.

So why is a savings account is a tragic waste of potential?  Well let’s say you have maxed your TFSA ($25,500) in a high interest saving account at Royal Bank for a 1.1% yield.  That would be a big old $280.50 in interest per year.  Taxed at a marginal rate of 39%, you saved $109 in taxes. Not bad right?

In my TFSA, I buy stocks that mirror my bills since I’m interested in mature businesses that pay a good dividend or distribution.  My current holdings are: AQN, BCE, D.UN, NPI, and REI.UN.  In total these stocks pay me $1982 a year to hold them or if you compare that back to my contributions that is a 7.8% yield. That is a high yield, but like I said this is my high risk account, I would be insulted if I wasn’t being paid well for taking the risk.  Now just on the distributions (39% marginal tax rate) and dividends (17.9% marginal tax rate) I save about $505 per year on taxes.  Yet it gets better, I also save any capital gains taxes on anything I sell as well.

So it is safe to say I’m saving likely five times the taxes that people who have their TFSA in plain old savings accounts.  So what’s the deal?  Why do people use their valuable TFSA contribution room on just savings?  Well, the TFSA title tends to confuse some people, but the other thing is people focus too much on their marginal tax rates.  I’ve been asked several times why I’m putting dividend paying stocks in my TFSA since they think saving at your 39% marginal rate is better than a mere 17.9% for dividends.  The issue is how much yield are you saving the tax on, even if you ignore the income trusts in my TFSA I’m still saving $226 per year on tax on just the dividends.  I’ve got much more yield that even at a lower tax savings I’m still coming out ahead.

So the lesson for today is: don’t let the your marginal tax rate drive your investing behaviour, check the math when making investing decisions.  So what do you have your TFSA account invested in?


The Tax I LOVE to Pay

Posted by Tim Stobbs on April 4, 2013

I think I have a similar point of most people when it comes to taxes.  I don’t mind paying them if they provide good service, but I don’t want to pay more than required.  Yet when it comes to my yearly tax bills there is one they could potentially double and I would still pay with a smile on my face.


Yes, you did read that correctly.  I like paying one of my taxes, actually forget that, I LOVE paying this one tax.  Which one? A small part of my property tax bill is devoted to our local library system which I gladly pay and hell I would still be getting a bargain even if they doubled it.

Why? Because for the mere $200 or so I pay in tax each year I’m saving a TONNE of cash.  How much?  Well I haven’t actually tracked a full year of what we borrow from the library, but this is what we have borrowed in March alone:

  • 12 books for my wife
  • 12 kid movies (including a full season of Star Wars Clone Wars as one item)
  • 15 kids books
  • 5  DVDs for me
  • 3 book for me
  • Two ebooks for me
  • and a partridge in a pear tree

What what exactly would all this retail for?  Well it sort of hard to say since I don’t actually pay for these and haven’t in such a long time I often don’t have a clue how much someone would pay to rent a DVD.  I’ll go with a rough estimate of $4/DVD rental (based on the prices on iTunes and Google’s Play stores).

The books are  a bit more complex.  My wife tends to borrow more paperbacks than I do, but new hardcovers are really pricey, so I’ll just average them and say about $14/book.  The kids books include the little level reader ones and hardcovers so again the prices vary, but let’s average $12/book.

So in total the movies were worth 17 x $4 = $68, the kids books were worth 15 x $12= $180, and the adult books 17 x $14= $238.  Or in grand total $486 for March alone.

Now March was a bit high for books for my wife, but otherwise a fairly normal month for us.  We like to read and watch movies a lot so we tend to borrow a lot of material. Yet to be fair I’ll scale that down by 20% to be more representative of a long term average, so that would take it down to $389.  So over a year our library usage is worth $4668 for the mere tax of $200/year or over 23 times the value I pay for it. And people wonder how I’m able to live on so little.  ;)

Yes the library is the best tax payment I make ever year.  Now a fair number of people don’t realize how great the library really is and thus don’t use it.  So to those people I will say: thank you for paying for my family to use all that material. Just because they are too impatient to wait for a hold to come in, I get easier access to my materials and still save a boatload of cash.

So what’s your best tax bill you pay each year?  Or what do you love/hate about your local library?