Five year-end tips to trim your tax bill
For working and retired investors, these measures can be useful – especially if they are employed before the end of 2014
By: SIMON AVERY
Date: December 18,2014
In this season of gift giving, it’s worth remembering that one area in which you don’t want to be overly generous is your taxes.
Dec. 31 is the deadline that the Canada Revenue Agency sets for numerous rules that allow you to trim your tax bill, which makes this time of year a critical moment for assessing your financial situation, if you haven’t done so already.
Most Canadians know, for example, that to benefit from the government’s education savings grant for this year, they must have made their RESP contributions by the end of December.
But there are other tactics that can prove even more fruitful if they are used before year end. Peter Bowen, vice-president of tax research and solutions for Fidelity Investments Canada, offers five timely tips for the season, which apply to working and retired investors.
One – Make gifts in kind
First, regarding charitable donations, consider in-kind gifts to registered charities. These may include publicly traded shares or stock options, units of a mutual fund trust, units of mutual fund corporations, government savings bonds and even certain categories of land.
If a donor sells the asset with the intention of donating the received cash, he or she will have to pay tax on any capital gains. The rate the CRA uses to determine the taxable capital gains is called the inclusion rate, which in most cases is 50 per cent of the actual gain. However, if the asset is donated in kind, then the inclusion rate is zero, which means no taxes are due on the capital gain. In addition, the donor still receives a charitable receipt for the full value of the asset donated.
If you want to benefit from this process for 2014, it is important to budget for the extra time charities may require to process the necessary paperwork, Mr. Bowen advises.
Two – Consider tax loss selling
Second, concerning capital gains (and losses) on other assets, consider tax loss selling. This is a process to reduce taxes you owe on any capital gains by applying capital losses against those gains. You can carry a capital loss back to previous years. Specifically, a loss recorded in 2014 can be used to reduce taxable capital gains this year and in 2013, 2012 and 2011.
This rule means an investor should look at all holdings in a loss position outside of a registered account and consider selling those assets. As attractive as tax loss selling might be from a tax perspective, however, it’s important not to dump assets solely for the tax benefit. “Investment fundamentals are important,” Mr. Bowen says. “Consider the investing merits of the asset and use tax loss selling as a catalyst to exit poor positions.”
Investors should also understand that trades must be settled by the end of the year, he says. Most stock trades, for example, settle three days after the order is executed. With the TSX and other Canadian exchanges closed on Dec. 25 and Dec. 26 this year, a sell order needs to be made by Dec. 24 to settle by Dec. 31. Furthermore, if you think you can fool the CRA by selling the asset at the end of one year and repurchasing it in the new year, you will be in for a nasty surprise. If the asset is repurchased within 30 days, CRA will deny the capital loss, Mr. Bowen says.
Three – Timely TFSA withdrawals
That said, there are other ways to use the calendar to your advantage. Tip three involves tax-free savings accounts. This year the CRA allows Canadians to deposit $5,500 into their TFSAs, where the money can grow tax-free and be withdrawn at any time without penalty.
If you are planning on spending money from your TFSA next year, consider withdrawing the amount this year, even if you don’t require the cash immediately, Mr. Bowen says. The CRA allows you to put back into your TFSA account the value of what you withdrew, but you must wait until the next calendar year to do so. Withdrawing the amount at the end of December essentially does away with that waiting period, allowing you to maximize your tax-free investing as early as possible, he says.
Four – Avoid bracket creep
Tip four applies to early retirees. Typically, Canadians find themselves in their highest tax bracket during their last few years of working. If they retire early, they usually see their income drop, landing them in a lower tax bracket. When they reach age 65, their taxable income gets a boost with Canada Pension Plan and Old Age Security payments. Then when they turn 71, it rises again with mandatory withdrawals from their registered income fund, or RRIF. Each gradient brings a bigger tax bill, and if their taxable income reaches $71,592, the government will begin to claw back OAS payments.
Mr. Bowen advises that early retirees manage this journey by triggering certain taxable income while they are in the lower tax bracket. That could mean selling certain assets and incurring the capital gains tax – or withdrawing money from an RRSP and paying the tax – before reaching age 65 or 71.
Five – Heads up at 65
Tip five speaks to those hitting age 65. When you reach this magic number, more types of pension income qualify for special tax treatment. For example, you should try to take advantage of CRA’s pension income credit, as well as rules that allow spouses and common-law partners to split pension income, he says.
To do this, you need income beyond OAS and CPP benefits, because in the CRA rulebook they do not qualify as pension income. However, income from a RRIF, does qualify. So Mr. Bowen advises that Canadians consider generating pension income by turning some of their RRSP into a RRIF before the government requires them to. Canadians must convert their RRSPs into RRIFs once they reach age 71, but by doing a partial conversion earlier, you can take advantage of the more favourable tax rules, he says.
The pension income credit allows you to claim a federal tax credit of up to $2,000 of eligible pension income. Pension income splitting can be worth a lot more. One thing to remember is that the pension income amount is a “use it or lose it” tax credit, which means it cannot be carried over from year to year.