The federal government has recently taken away several tax advantages enjoyed by individual Canadians and businesses, from ending tax-free switching of corporate class funds to removing key benefits of income sprinkling. Though some immediate tax-saving methods are gone, tax-deferral methods remain – and that may be the next best thing.
Deferring tax is not just a matter of postponing the inevitable. In fact, it offers three potential benefits. First, you keep more money to support your current lifestyle. Second, when investing, deferring tax means that more of your money is working for you, to grow and compound. Third, you often gain control over when to pay the tax, which may be at a time you’re in a lower tax bracket.
Tax deferral for individuals
Here are several methods of deferring tax for various components of a financial plan.
Build greater wealth. With a Registered Retirement Savings Plan (RRSP), you defer tax two ways. Deducting your contribution amount reduces the income tax you pay, and that tax is deferred. Also, all interest and growth within your plan is deferred, enhancing compound growth.
You can also defer tax in a non-registered account by holding growth stocks for longer periods. Capital gains aren’t taxed until you sell the stock. Note that taxation should not be the primary consideration when making investment decisions, and deferring tax only applies to buy and hold, not active buying and selling.
Sell property with taxation deferred. When you sell capital property, such as vacation property or stocks, you may be able to claim the capital gains reserve. You and the purchaser agree to spread the transaction over a maximum of five consecutive years. The reserve refers to the amount of the purchase and resulting capital gain being deferred. This strategy provides a series of manageable tax payments and, in some cases, keeps the taxpayer in a lower tax bracket versus reporting 100% of the sale in a single year.
Increase retirement income. When selecting vehicles to help provide retirement income, you can choose funds or other investments with distributions that include return of capital. You don’t pay tax on return of capital, so you keep more of the income. Also, non-taxable income can help avoid clawback of Old Age Security (OAS) benefits. This is a tax deferral – you’ll eventually have taxable capital gains on regular distributions or upon selling the investment.
Preserve estate assets. Upon passing, tax on RRSP or Registered Retirement Income Fund (RRIF) assets and tax on capital gains of estate assets can be considerable. The tax is deferred when you leave the assets to your spouse, until the spouse sells the assets or passes away. The tax deferral also applies if you establish a spousal trust to provide your spouse with income during his or her lifetime.
Tax deferral for business owners
A couple changes have restricted business owners’ ability to save tax on corporate investments – decreased limits on passive income and on investment amounts in universal life insurance policies. But you can still defer tax on investments using an individual pension plan (IPP) for retirement savings. Contributions are typically greater than those in an RRSP – in fact, the IPP is often called a supersized RRSP. Also, contributions are tax deductible to your business.
Another tax deferral strategy is the estate freeze, used when you plan to transfer the business to your children. An estate freeze solves the problem of triggering a large taxable gain on the owner’s business interest when the owner passes. You lock in the current business value now, and the capital gain is assessed at the time of the freeze. Tax on the capital gain is only due on your final tax return. Growth of assets after the freeze will eventually be taxable to the children.
Feel free to talk to us about any tax matter, whether it involves investments, retirement income, estate planning or business.