As the old saying goes, the only thing that is inevitable if you are still living is paying tax to our “friends” in Ottawa. We all think that we pay too much income tax and most people probably do. In this column, I will address some topics which may allow you to reduce the amount of income tax that you pay in the future.
Tax Free Savings Account (TFSA)
The term Tax Free Savings account is in my opinion misnamed. I believe that they should be called a Tax Free Investment Account. Many investors think that the only available investment for a TFSA is traditional savings account the currently pays you a very minimal amount of interest (1-1.5%).
Any investment that is eligible for an RRSP such as stocks, mutual funds, bonds, ETF’s etc are also eligible for a TFSA.
TFSA’s started in 2009 and are now a large part of investment planning for people of all ages. You can open a TFSA if you are a Canadian resident, are age 18 or older and have a Social Insurance Number. You can contribute a maximum of $5,500 per year and there is no upper age limit of 71 like an RRSP. In years where less than the maximum amount is contributed, the unused room is carried forward. Funds can be withdrawn at any time and for any purpose and will not incur any tax if there is any interest, capital gains or dividends. Most financial institutions like investment firms and banks offer TFSAs.
There is some debate as to what investments an investor should put in a TSFA. Some think that very aggressive investments with a large return potential would be the best strategy while others think that tax sheltering interest income from a conservative bond or GIC is more suitable. I would recommend discussing investment options with your investment advisor to decide on a strategy that would be best for your TSFA.
Flow-Through Limited Partnerships (FTLP)
Over the past several years the Dept. of Finance has moved to eliminate loopholes that are systematically exploited to save or defer tax. It is reasonable to say that there are very few tax shelters that are currently permitted under the Income Tax Act. One such shelter is a flow-through LP.
Canadian resource companies operating in the oil and gas, mining and renewable resource industries often incur significant expenses associated with exploration and development. To fund these expenses, the companies will issue flow-through shares to investors. The companies renounce this portion of their expenses to the shareholders who then can claim the deductions for tax purposes.
In recent years, many flow-through investors have taken the route of a professionally managed FTLP in order to reduce company-specific risk. An FTLP is managed by a professional money manager who selects a portfolio of flow-through shares. FTLP investors can typically write off the entire investment against any type of income in the year that it was purchased. After a hold period of 1 to 3 years, the assets of the FTLP are rolled into a mutual fund which can be held or sold.
I will outline several ways that I have seen my clients utilize FTLP:
1. Selling the Farm of Business
People will often pay the most tax in their life in the year that they sell the farm or a business. Investing in a FTLP in the year of the sale can offset much of the tax liability.
2. Charitable Giving
Would you donate to charity if you could save up to 92% on your tax bill? Here’s how it is done (assuming 46% tax rate): investor purchases $100,000 of FTLP and saves $46,000 of income tax. Investor donates the rollover mutual fund worth $100,000 to charity (assuming break-even on the FTLP) and receives another tax saving of $46,000 for the charitable donation. Net tax savings to the investor = $92,000.
3. Reducing Taxable Income
Investors purchasing an FTLP reduce their income in the year of purchase by the amount of the investment. For example an investor in a 46% tax bracket would save $13,800 on a $30,000 FTLP investment.
4. Avoiding Old Age Security Clawbacks
Seniors with income over $71,000 begin to lose some of their OAS payments and do not receive any payments once income exceeds approximately $115,000. This problem is compounded by the fact that the minimum Registered Income Fund withdrawal increases every year. Seniors have the opportunity to not only save income tax but to restore part or all of their OAS payments.
Other tax saving strategies that investors can utilize include:
- Maximize RRSP contributions.
- Combine charitable and medical expenses for both spouses on one income tax return.
- Review you investment mix for tax efficiency. Interest income is taxed at a higher rate than dividends and capital gains so interest bearing securities should be kept to a minimum in non-RRSP accounts. Instead, keep bonds and GICs inside your RRSP.
- Use a good accountant who is up to date on current tax issues.
And most importantly, hire a well qualified investment professional who is well versed on tax strategies and investment planning. Happy investing!!
As always, consult your investment advisor prior to investing. This column is provided for information only and is not a solicitation to buy or sell securities.
Vice President and Wealth Advisor
BMO Nesbitt Burns Saskatoon
Jim has been an advisor for 17 years and specializes in working with farm families in the areas of investment, tax and estate planning.