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If your New Year’s financial resolutions have already evaporated, despite your best intentions, you might try just one more: create tax-free dollars. There’s no special magic involved here. Nor is there any particularly daunting effort needed. The money is just sitting there waiting for you to take it. Here’s how.
Tax Free Savings Account (TFSA)
This is by far the best way to create tax-free dollars. And by not opening a TFSA, you’re leaving it on the table. Say you are 30 years old and make $50,000 a year. You have $10,000 in your TFSA and you contribute $5,000 at the start of each and every year until you stop working at age 65. Let’s assume your combined investments inside the TFSA earn an average compounded 8% annually. (This is actually possible, as some long-term conservative mutual funds deliver these types of returns and more.) When you reach 65, you would have $1,067,412. Yes, over one million dollars from a $5,000 annual investment.
If you were to invest this same amount in a non-registered taxable account, using the same numbers, you would have $728,226 by the time you retire, and would have paid a whopping $271,774 to the CRA. This is because the growth on your investments is taxed annually at your marginal tax rate (in this case let’s say 31.15%), leaving you an after-tax rate of return of 6.4%. Congratulations! You have just given the CRA a bonus of $270,000 for absolutely no reason!
The secret is that you never ever pay tax on the money inside your TFSA or when you withdraw it – no tax ever! So you can invest in interest-bearing investments like bonds and GICs, or aim for more growth in the form of investments like common stocks, mutual funds, and ETFs. So max out your Tax Free Savings Account every year. And do it regardless of how old or young you are today. Stop giving your money away!
DPSPs and Group RRSPs
Employers often use group benefits as a way to attract and retain their best employees. But because of employer contributions, it’s like free money for the employee.
* Deferred Profit Sharing Plans (DPSPs). Essentially, a DPSP is a type of registered pension plan (it must be registered with the Canada Revenue Agency) that is funded solely by the employer, based on the profitability of the business. The employer will make contributions on any schedule they choose and only if there are profits to share.
Employees can generally decide how the DPSP funds are invested, and those participating in the plan do not pay tax on the contributions made to their DPSP until the money is withdrawn from the plan. For the employer, a DPSP has definite tax advantages in that contributions are made from pre-tax income, are tax-deductible for the employer, and are not subject to either federal or provincial payroll withholding tax or EI and CPP/QPP deductions.
An employer can contribute a maximum of one half of the money purchase limit for the year (that is, one half of $26,500 in 2018, or $13,250) or 18% of the employee’s compensation in the year (based on the year’s maximum pensionable earnings – $55,900 in 2018), whichever is less.
* Group Registered Retirement Savings Plans (RRSPs). DPSPs are often used in conjunction with a Group Registered Retirement Savings Plan. These basically has the same structure as an individual RRSP, except that they are administered by the employer, and individual investment choices are typically limited.
Both employer and employee contribute to the plan. The employer’s contribution is another instance of free money that those who don’t partake in the plan are leaving on the table. Contributions are tax deductible, and like individual RRSPs, tax on any investment growth inside the plan is deferred until you collapse the plan. Contributions are made by regular payroll deduction. Because this is an RRSP contribution, it results in a tax deduction, which can be applied to reduce the employee’s source withholding, in effect giving the employee an instant tax refund. Employer contributions are not mandatory but are usually made as an additional employee benefit.
If an employee leaves the company, their proceeds from the Group RRSP can be transferred to their individual plan or to a Registered Retirement Income Fund or annuity if at or close to retirement age. Taking the proceeds in cash will be considered taxable income in the year received and will be taxed at the employee’s marginal rate for the year.
While the management of Group RRSPs is typically contracted to institutional managers, this may not always be the case. If you have doubts, check with an independent financial advisor about the calibre, qualifications, and performance history of the money manager before signing up.
Registered Education Savings Plan (RESP)
If you have children (or plan to have children), an RESP allows you not only to save for your children’s post-secondary education but it also provides a way to both diminish and divide! You “diminish” by paying no tax and “divide” by splitting income with your children.
When you make a contribution to an RESP, you are transferring future tax liability by essentially putting money into your children’s names. The money grows tax-free until they withdraw it pay for a qualifying post-secondary institution. The investment growth is taxed at the child’s tax rate, which will presumably be next to zero, while you will very probably be in your peak earning years with a tax bracket as high as 46%. You have just accomplished what may be a decade of tax-deferred growth. When it is done right, you will pay no tax on the growth, and your child’s college or university education will be largely paid for.
But here’s the kicker: The federal government will also give you up to $500 a year to a lifetime maximum of $7,200 as part of the Canadian Education Savings Grant (CESG). That’s free money.
To get tax-free money, you have to take maximum advantage of the various registered plans available. Mostly, it’s as simple as going to your local bank branch and opening an account, or signing a participation form with your employer in the case of group plans. Consult a qualified financial advisor, such as a Certified Financial Planner, if your financial situation is more complex or if you’re in a higher tax bracket. In any case, this year resolve to get some tax-free money!
Robyn Thompson, CFP, CIM, FCSI, is the founder of Castlemark Wealth Management, a boutique financial advisory firm specializing in wealth management for high net worth individuals and families. Contact her directly by phone at 416-828-7159, or by email at rthompson@castlemarkwealth.com for a confidential planning consultation.
Notes and Disclaimer
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The foregoing is for general information purposes only and is the opinion of the writer. Securities mentioned are illustrative only and carry risk of loss. No guarantee of investment performance is made or implied. It is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice. Please contact the author to discuss your particular circumstances.
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