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Spring forward – advance on 2014 tax year with a plan

A financial advisor can help establish smart habits that can minimize the tax bite, maximize income and avoid the last-minute crunch

By: VIRGINIA GALT

Date: May 27,2014

Relieved to be through with this year’s annual tax exercise? Can’t bear to think of next year’s date with Canada Revenue Agency? Yet financial experts say there is no time better than the present to explore effective strategies for maximizing after-tax returns.

“We always like to procrastinate … but setting up a meeting [now] with a financial advisor and your accountant, as the case may be, can pay dividends into the future,” says Peter Bowen, a chartered accountant and vice-president, tax research and solutions, at Fidelity Investments Canada.

Starting tax planning in the spring “has the advantage of everything being fresh in mind,” Mr. Bowen says.

“It’s a good time to go to a financial advisor, talk about last year’s situation and talk about the future because … people need to think long term about these things,” factoring both their registered and non-registered investments into the overall planning process.

“Too often it is just done in a rush, in terms of RRSP season and making investments. And when they file their tax return, that’s often done on a reactive basis, based on what happened [in the] last year,” Mr. Bowen says.

Advance planning can also prevent unexpected tax hits at year-end, says Denham Patterson, a partner at Toronto-based Bennett Gold LLP Chartered Accountants.

“Procrastination in dealing with your taxes can lead to a very real, very heavy monetary cost. All of a sudden that investment that you made eight months ago doesn’t seem all that attractive the following April,” Mr. Patterson says.

Canadians are well-acquainted with the benefits of registered retirement savings plans (RRSPs), which allow them to deduct contributions against taxable income and shelter the growth of their investments. Even so, many Canadians do not maximize those benefits or carefully consider their investment options within those vehicles, Mr. Patterson says. “The whole purpose of an RRSP is for you to be able to earn tax-deferred income until you retire, but they wait until March 1 of the following year [to reduce their taxable income in the previous year].”

He recommends that people make their contributions for the 2014 tax year as early as possible, rather than waiting until next March. “You still get the same deduction, but have added one more year of tax-deferred income to your RRSP portfolio.”

When it comes to non-registered accounts, different investments attract different treatment from CRA – and minimizing the tax bite on those investments can be a challenge.

Mr. Patterson says often accountants do not become aware of the tax consequences of a client’s transactions until well after the fact – at tax filing time.

Mr. Bowen says most financial institutions offer products specifically designed for tax efficiency, and that’s an investment avenue taxpayers might want to consider, depending on their circumstances.

“An example that we often talk about is corporate class investing, which is a set of mutual funds contained within a single corporate entity.” These corporate class funds, offered by virtually all the major fund providers, give investors the flexibility to rebalance their portfolios without triggering immediate capital gains. “They can shift investments … on a tax-deferred basis, and that can take advantage of the compounding effect of money and leave them better off in the long run,” Mr. Bowen says.

“The other thing that corporate class structures can give is the potential for reduced taxable distribution, so most of the benefits of corporate class tend to defer taxes into the future and reduce a person’s overall tax bill.”

But, he stresses, the appropriate tax planning strategy very much depends on the taxpayer’s age and stage.

“People really do need to think of this as a lifetime of tax-smart investing. Each individual’s circumstances are different, and that’s why working with a financial advisor can be very beneficial, to look at the different phases from a tax perspective of one’s investing life,” Mr. Bowen says.

“By doing what we call tax-bracket management, people can maximize their after-tax returns over the course of their life.

“So, for example, someone who has retired early and is not yet receiving Old Age Security or not yet getting RRIF payments out of a registered retirement income fund [RRIF] might want to trigger some taxable income because they are in a very low tax bracket for that period of time.

“They will pay some tax on those amounts that they take out of the registered account, but what that can mean is that they pay tax at a relatively low rate when they do this, knowing that at some point in the future they start to receive OAS payments and get payments out of a RRIF and they will be subject to a higher tax rate, especially if they are subject to an Old Age Security clawback, that can have a surprisingly large impact on one’s effective top marginal rate,” Mr. Bowen says. “People really do need to plan for that.”

At the younger end of the spectrum, taxpayers with children – accustomed to the child-care expense deduction – might not factor in the reduction in their child-care expenses when the child starts school, Mr. Patterson says. “All of a sudden, a sizeable deduction you have claimed has decreased or is gone completely. Your refund is no longer as big as it used to be, or there may be no refund at all.

“It’s things like that people miss or just take for granted because they think one year is much the same as the next … but circumstances change.”

On the other hand, Mr. Bowen says, “if you are getting a large refund, you have essentially made a large interest-free loan to the government, so you should be asking why you are getting such a large refund and is that appropriate, so is there a way to reduce withholdings at source, for instance, so that next year you are not getting a large refund … and can take advantage of the additional cash flow you might get each month.”

The key, Mr. Patterson says, “is not to think of income tax as a one-off at the end of the year and then you are done with it, but it is a continuous process … there is always a tax issue to everything we do.”

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