No one likes paying taxes. Tax evasion is illegal but you have the right to reduce the taxes you pay to the least amount possible. You want to pay attention to your financial affairs during your working years to be the most tax effective.
The key components of smart tax planning are the three “D”s – deduct, defer and divide.
Reduce your taxable income by using all of the tax deductions and tax credits you are allowed. Some tax credits you can claim are:
- Medical expenses for any 12 month period
- Charitable donations
- Dividend tax credit
- First time home buyer
- Tuition and student loan interest
Some provinces have their own deductions, for example Nova Scotia has a tax credit for healthy living and children under 6.
If you use tax software such as TurboTax, the program will ask questions and walk you through all the deductions so you won’t miss anything and will offer the most advantageous way to make a family claim on medical expenses and donations.
Earn money now and delay the tax you pay on it until sometime in the future when it’s more advantageous for you. For example, contribute to RRSP’s and pension plans. When you retire and withdraw the money, hopefully your tax rate will be lower than it is during your peak earning years.
Split income with family members who are in lower tax brackets to reduce your family’s overall tax burden. Examples include:
- Loaning money to a lower income-earning spouse in order for them to invest the funds and claim the investment income.
- Spousal RRSPs – Use especially when one spouse has considerably higher income or a substantial company pension plan. The amount contributed has to be within your contribution limits.
- Education savings plans (RESPs) – Amounts withdrawn for education purposes will be taxed at the child’s lower income level.
- Retirement income split between spouses – Eligible income for splitting can come from registered pension plans and annuities (under age 65) and withdrawals from RRIFs and RLIFs and interest from non-registered annuities (age 65 and over).
- Canada Pension Plan sharing – Spouses who are at least 60 years old and receive CPP can share their pension benefits. To take advantage of this, you need to make a formal request through Service Canada.
Income splitting is suitable for couples with a significant difference in income as it results in paying an overall lower tax. A 50/50 split may not be the ideal for everyone. You need to play around with the numbers to determine what works best for you and your spouse.
Beware of fraudulent schemes involving RRSPs and charitable gifting that claim to save or eliminate taxes. Use all the legal means available to reduce them.