Now that tax season is underway, it’s time to look over your financial records from last year and determine your options for reducing your tax liability. You should pay what you owe, of course, but why pay more than you need to?
We’ve also just passed the season for that well-known Canadian tax deduction: the registered retirement savings plan (RRSP). In the first two months of the year, many Canadians rush to their financial advisors or banks to put money into their RRSPs to get a tax deduction for the previous tax year.
There’s no doubt: Contributing to an RRSP is a great way to lower your tax bill. But the tax code is large, and you might not be aware of all the other options you may have to pay less income tax. This year, go beyond the common tax breaks you know and consider some of the others you might be eligible for.
Children’s arts amount (Line 370)
If you pay for your children to be involved in developmental, cultural, or artistic activities, you might be eligible for a tax credit. According to Mike Oseen, Senior Tax Manager at Grant Thornton LLP, this tax credit means effectively 15% of the activity fee is treated as tax paid.
For the children’s arts amount, you can take a credit of up to $500 per child for the cost of registration or membership in the activity. This applies to your spouse’s child, or your common-law partner’s child, as well as your own.
Children’s fitness amount (Line 365)
Not only are you encouraged to boost your children’s achievements in the arts, but you are also encouraged to help your child live healthier. The children’s fitness amount is a tax credit that applies to fees paid for participation in sports or some physical activity. Once again, you can claim up to $500 per child, for your child or your partner’s child.
Home-buyers’ amount (line 369)
Did you buy a home last year? If so, you might be eligible to claim up to $5,000 as a tax credit. To do so, you have to meet both the following conditions:
The idea is to encourage first-time home buyers. If you have a disability, though, you don’t have to be a first-time buyer. (See persons with disabilities.)
Public transit amount (line 364)
Your efforts to be a little greener as you get to work can result in another tax advantage. If you buy monthly or annual passes for travel within Canada on qualified public transit, you can get a tax credit for what you spent last year.
Moving expenses (line 219)
Did you move to be closer to work? If so, you might be able to get a tax break for your expenses. You could be eligible for this advantage if one of the following applies to you:
You do have to move at least 40 kilometres closer to your new workplace (either a different location of your current employer or a new employer) or school to qualify, though. Eligible moving expenses include packing and moving your household goods, the cost of selling your old home, and utility hook-ups and disconnections.
Moving expenses are a little different from the other breaks mentioned in that they are a tax deduction as opposed to a tax credit (they reduce the amount of income you pay tax on, whereas a tax credit reduces the amount of tax you owe).
Consider your situation and think about what you spent last year. Check with the Canada Revenue Agency or a trusted tax preparer if you aren’t sure if you are eligible for these tax breaks.
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Should you contribute to a Registered Retirement Savings Plan (RRSP)? With Tax-Free Savings Accounts (TFSAs) becoming more popular, there’s debate among financial experts on the pros and cons of each type of account. But RRSPs are still an essential tool for saving for retirement, provided you use them wisely. You still have time—the RRSP deadline for contributions eligible for a 2014 tax deduction is March 3, 2015. But before you jump in, read these three guiding principles for using RRSPs successfully.
Principle #1: Contribute
You can’t start a journey without taking that first step. So open up an RRSP if you don’t already have one. Next, contribute regularly! Money contributed to an RRSP grows tax-free inside the plan, and gives you a tax-deduction for the year of contribution. In effect, you are contributing before-tax dollars that will compound and grow free of tax. You’ll be taxed on withdrawals when you collapse the plan (usually at retirement), but your tax rate will likely be lower than it is in your peak earning years.
You can contribute 18% of ‘earned income’ to an RRSP every year to a pre-set maximum. For 2014, the maximum contribution limit was set at $24,270 (for 2015, it is set at $24,930). If you can’t contribute your maximum in a year, contribute as much as you can.
Make monthly contributions, and start now! The sooner you start tax-sheltered compounding in your RRSP, the better. Start off with small amounts, gradually increasing as your salary rises. Remember the magic of compounding. Even a $500 monthly investment compounded monthly at a relatively conservative rate of 6% will grow to $500,000 in 30 years.
You can also increase your contribution in a given year by using ‘contribution room’ you’ve carried forward from previous years. And you should also reinvest your tax refund to increase your nest-egg.
Looking for ways to make RRSP contributions? Here are some favourites:
Automatic deposits. Arrange with your bank or your employer (if they’ve set up a group RRSP) to automatically deposit funds to your RRSP with every paycheque. Contributing through the year gets your money invested and compounding that much sooner.
Severance payments. If you received a severance payment in 2014 (and you haven’t already blown it on something), use it to make an RRSP contribution. That way, you’ll shelter some or all of the severance amount from income tax.
Inheritances. You may have received a bequest during the year. If it’s a substantial sum, use at least some of it as an RRSP contribution. Bequests themselves are generally not taxable as income, but any investment income from that bequest is. So put some of it into an RRSP, where investment growth is tax-sheltered until your RRSP matures.
Contributions in kind. If you have qualifying investments outside an RRSP in a non-registered account, consider transferring some of them to an RRSP. Their current value will be deemed to be the contribution amount for tax purposes. If you make this type of contribution, keep in mind that there will be a ‘deemed sale’ of the asset, and 50% of any capital gain may be taxed. However, the upside is that you’ll get a tax deduction on 100% of your contribution. To make contributions in kind, you’ll need a brokerage account or have a self-directed RRSP that lets you pick and choose your own investments.
Should you borrow? The biggest downside to borrowing your RRSP contribution is that you are leveraging your investment. It makes no sense to put borrowed money into a safe, interest-bearing investment like a GIC, because it earns less than the cost of your loan. But if you invest in equity investments, either directly or through a mutual fund or ETF, you run the risk of magnifying any losses that may occur. In other words, the value of your investment may end up being less than the value of your loan—never a good situation!
Another minus is that an ‘RRSP loan’ is still a loan—a debt with interest payable. And you must pay the lender (usually your friendly neighbourhood bank) the money when it’s due, regardless of what happens to your RRSP investment or anything else. People who jump into RRSP loans without thinking about the effect on their cash flow are usually in for a rude awakening.
Speak with your financial advisor or qualified planner about more complex RRSP contribution ideas, such as contributions in kind or RRSP loans.
Principle #2: Invest
Putting your RRSP funds in a savings account or a GIC might sound ‘safe,’ but that strategy fails to make optimal use of the RRSP’s most powerful feature—long-term tax-sheltered compounding. RRSPs may hold a wide variety of investments. And with the right asset mix, you can boost your investment return far beyond what’s offered by the meagre returns on savings accounts or GICs. Here’s a quick list of what the Canada Revenue Agency says are qualified RRSP investments. For more detail, check the CRA website:
Principle #3: Know yourself and invest wisely
For many of us, an RRSP is our only source of retirement income apart from the Canada Pension Plan. And while you can invest in just about every type of asset class, an RRSP is not the place to speculate on junior mines, high-tech start-ups, commodities or other risky and volatile assets, even though they might be qualified investments as seen in the list above. Remember—tax benefits like the dividend tax credit, the capital gains tax exemption and the ability to offset losses against gains are lost within an RRSP.
Aside from not contributing to an RRSP at all, the RRSP investment choice is where most people go astray. Most of us tend to overestimate our capacity to deal with market volatility and take investment losses. So be realistic about your own tolerance for risk (and ignore what your neighbour, uncle or barber thinks—they generally exaggerate!). Work with a qualified financial planner to allocate your RRSP assets according to a plan determined by your personal goals and a realistic assessment of your tolerance for risk.
Image of RRSP from Shutterstock.