2020 will no doubt go down as one of the most monumentally disruptive and headline-intense years on record. Nonetheless, even a global pandemic is no excuse not to get your planning ducks in a row and consider ways to economize on taxes and plan your wealth strategies for the 2020 year end. As we enter the final weeks of 2020, we’ve listed a few helpful strategies that may be useful across various types of taxpayer categories:
2020 was a tumultuous year in global markets, and many investors with holdings in non-registered accounts may still be sitting on unrealized capital loss positions. Tax-loss selling involves selling investments with an accrued capital loss position at year end in order to offset capital gains elsewhere in your portfolio (or just to reduce taxable income in general). In the event that there are not current-year capital gains to offset (or your loss is larger than the current-year capital gains), investors may also carry back losses three years or carry them forward indefinitely to offset capital gains in other years.
Investment Type | Purchase Date | Sale Date | Adjusted Cost Base (e.g. Original Price + fees) | Sale Price | Current Market Value | Unrealized Capital Gain/Loss | Realized Capital Gains/Loss** | Taxable Gain/loss (50% of realized capital gain are taxable) |
Security A | Jan 1, 2020 | Feb 1, 2020 | $510 | $910 | $400 | $200 | ||
Security B | Jan 1, 2020 | Dec 1, 2020 | $910 | $510 | -$400 | $200 | ||
Security C | Jan 1, 2020 | Dec 1, 2020 | $260 | $60 | -$200 | 0 |
From the Canada Revenue Agency’s perspective, the taxable gains and losses exactly offset one another and no tax is assessed for these transactions. Moreover, in the event that losses were especially significant in this year – remember that they can be carried back three years to offset gains in prior tax years. Make sure you have documents on hand to prove the adjusted costs basis and sale prices of your securities in order to provide the necessary evidence for your tax loss selling strategy.
In this example, the investment merit and intrinsic value of the underlying security are being considered in tandem with tax strategies – a characteristic of high quality financial planning advice. It is important not to let a single factor influence all of your decision making – sometimes what makes sense from a tax strategy perspective is at odds with an investment rationale, or another plank of your strategy.
By April 2020, over 5.5 million Canadians had experienced some kind of impact to their income, through either outright job loss, reduced hours or some other type of disruption. The Canadian government’s response – the Canada Emergency Response Benefit (CERB) program resulted in direct transfers to Canadians without any tax being withheld. For the 2020 tax year, these direct payments will be considered taxable, ordinary income, and Canadians who received CERB payments should attempt to estimate their total taxable amount due on these payments and make the funds available for repayment to the CRA in 2021.
The CERB program has since formally ended, with three new benefit programs takings its place: the Canada Recovery Benefit (CRB), the Canada Recovery Sickness Benefit (CRSB) and the Canada Recovery Caregiving Benefit (CRCB). Just as with CERB, these benefits are also taxable, and although some amounts are being withheld at source (10%) – this may not reflect the ultimate tax that is required to be remitted on these amounts.
Registered Retirement Savings Plan (RRSP) contributions continue to be a wise strategy for the vast majority of taxpayers looking to benefit from the deferral of current-year income taxes and the tax-free growth of their principal. Although investors have until March 1, 2021 to make RRSP contributions for the current tax year, it is best to maximize time in the market and tax-deferral benefits by making these contributions earlier in the year, rather than later. Dollar cost averaging strategies that use up the 18% of income earned in 2018 (less pension adjustments) via a regular pre-authorized contribution plan can be a good choice – lessening the burden of trying to save up a large lump sum in early March, while lessening the impact of market volatility on the number of units bought over time. For example, many dollar cost averaging investors would have gotten extra bank for their buck in the extremely bearish Feb-April 2020 period when securities were on sale – simply by sticking with their regular, disciplined purchasing strategy.
Debt gets a bad rap, and well it (sometimes) should. Incurring debt for consumer purchases is generally to be avoided. On the other hand, debt incurred to generate long-term assets belongs to a different, far more preferable category. Debt incurred to generate long term assets with the added benefits of a tax refund amid a climate of record low interest rates…well that’s even better. Let’s examine the situation for an Alberta resident with a $75,000 income who is considering the choice between taking on an RRSP loan to top up their RRSP by $10,000, or just leaving it until next year. Let’s further imagine that our Alberta resident is generally a “Balanced” long term investor (let’s assume a long-term return of 6%) and can borrow at prevailing low interest rates of 3% (banks & credit unions usually make RRSP loan rates quite low).
Business as Usual Scenario | RRSP Loan Scenario ($10,000) | |
Income | $75,000 | $75,000 |
RRSP Loan Amount (e.g. $10,000) | $0 | $10,000 |
RRSP Contribution (e.g. $10,000) | $0 | $10,000 |
Taxable Income | $75,000 | $65,000 |
Tax Amount Due (Tax % * Taxable Income) | $16,285 | $14,204 |
Tax Refund Amount | $0 | $2,081 |
Loan Interest Cost | $0 | $165 |
RRSP Investment Return ($10,000 x 6%) | $0 | $600 |
Net worth gain on a deferred basis | $0 | $2,516 |
Yes, we realize that this tax refund may “eventually” be taxed – albeit at the generally lower marginal tax rates that prevail in most Canadians retirements. In the meantime, it will have the opportunity to grow tax deferred basis, and this is an extremely valuable benefit. Moreover, the client could take their refund and immediately apply it to the outstanding loan amount, thereby reducing their loan interest costs further (by an additional $36, assuming a 1 year amortization). So, the answer is a resounding, yes.RRSP loans make sense in the vast majority of cases.
Imagine we have a hypothetical young Albertan couple that are looking to purchase their first home. They have $50,000 of non-registered savings saved in a high interest account, or maybe a parent or grandparent has gifted them that amount. Either way, the couple has a house in mind, have entered into a “qualifying agreement” to purchase the property and are at-least 90 days away from closing on the sale. The buyers both earn $75,000 and have not been able to maximize their RRSPs over the years, and both have over $25,000 of RRSP room available. They are not expecting any significant pay raises in the years ahead, so the wisdom of deferring that RRSP room in the hopes of larger marginal tax rates in the years ahead is doubtful. Here, we examine the ramifications of using that $50,000 to top up both of their RRSP accounts first before subsequently withdrawing the funds at-least 90 days later under the tax-free Homebuyers Plan (HPB) withdrawal program.
Business as Usual Scenario | RRSP Contribution & HBP Withdrawal | |
Income | $75,000 | $75,000 |
RRSP Contribution (e.g. $25,000) | $0 | $25000 |
Taxable Income | $75,000 | $50,000 |
Tax Amount Due (Tax % * Taxable Income) | $16,285 | $8,660 |
Tax Refund Amount | $0 | $7,625 |
Down Payment Amount | $25,000 | $25,000 |
Net worth gain on a deferred basis | $0 | $7,625 |
Minimum HBP Payments Required per year for 15 years the second year after the withdrawal year. E.g. a withdrawal in 2020 means repayment must begin in 2022. | $0 | $1,667 |
It should be mentioned that if money is no object, and they have fully topped up RRSPs and ample down payment in a non-registered format, it is very likely unwise to take advantage of the Homebuyers Plan withdrawal. There is a real opportunity cost to withdrawing $25,000 from a tax shelter, particularly if the amounts are not fully repaid for the full fifteen years. However, if the HBP allows the twin benefits of taking advantage of RRSP room that would otherwise not be utilized, and the use of those same funds for a down payment – the strategy can be very useful. In many such HPB withdrawal scenarios, the tactic creates a welcome, and generously sized tax refund in the first year of home ownership when expenses for new furniture and home improvements are likely to be present – and both buyers here could take advantage of this, for a total refund amount of $15,250.
Delay Paying for Training Costs Until 2021
2020 is the first year in which you may be entitled to claim a new, refundable $250 Canada Training Credit (CTC) to help cover educational and training costs. For the 2020 tax year individuals can claim 50% of eligible tuition and fees up to the CTC account balance of $250 (subject to being a Canadian resident, between the ages of 25-65 and with employment or self-employment income between $10,000 and $147,667).
RESP’s continue to be excellent vehicles to help individuals save for the post-secondary tuition expenses of minor beneficiaries. The federal government provides a Canada Education Savings Grant (CESG) equal to 20% of the first $2,500 of annual RESP contributions per child or $500 annually. While unused CESG room is carried forward to the year the beneficiary turns 17, there are a couple of situations in which it may be beneficial to make an RESP contribution by December 31.
Each beneficiary who has unused CESG carry-forward room can receive up to $1,000 of CESGs annually, with a $7,200 lifetime limit, up to and including the year in which the beneficiary turns 17. If enhanced catch-up contributions of $5,000 (i.e. $2,500 x 2) are made for just over seven years, a maximum total of $7,200 can be obtained from Canada Education Savings Grants. In the event that you have less than seven years before your child or grandchild turns 17 and haven’t maximized RESP contributions, consider making a contribution by December 31, 2020.
Also, if your child or grandchild turned 15 this year and has never been a beneficiary of an RESP, no CESG can be claimed in future years unless at least $2,000 is contributed to an RESP by the end of the year. Consider making your contribution by December 31, 2020 to receive the current year’s CESG and create CESG eligibility for 2021 and 2022.
Maximizing these grants through RESP contributions goes a long way towards defraying future education costs – costs which tend to rise at a faster rate than the generalized inflation rate in Canada (The High Price of Higher Learning, Globe and Mail, Nov 8, 2019). Moreover, in the event that your child or grandchild (and any other siblings) doesn’t attend post-secondary education – the rules require that grant amounts be paid back. Amounts you contributed are returned to you without being taxed, while gains on contributions/grant/bond amounts, or ”accumulated income” are taxed at your regular income tax level, plus an additional 20 percent.
The TFSA dollar limit for 2020 stays at the same level as 2019 – $6,000. Canadians who have been eligible to accumulate room since the program started in 2009 would therefore have a total of $69,500 available to shelter after-tax income from tax.
A Review of Taxable vs. Tax Deferred (e.g. RRIF/RRSP/TFSA/RESP/RDSP) Growth
The benefits of tax-free compounding are quite significant for most investors. Consider the following example where we have an investor with $27,230 invested in a tax-exposed account (at the 28% marginal tax bracket) vs. a tax-sheltered account. In both scenarios, the investor earns a consistent 6% return (and in our example here, we are ignoring differences in the treatment of capital gains, interest and eligible/non-eligible dividends for non-registered accounts – we’ll just assuming its all interest income):
Registered Investment | Taxable Investment (28% marginal rate assumption) | |
Annual Rate of Return – 6% | 6% | 6% |
Initial year deposit (time = 0) | $27,230 | $27,230 |
Year 1 | $28,863 | $28,406 |
Year 2 | $30,595 | $29,633 |
Year 3 | $32,431 | $30,913 |
Year 4 | $34,377 | $32,249 |
Year 5 | $36,439 | $33,642 |
Conclusion: | 34% Growth from original principal | 23% Growth from original principal |
Major changes to the taxation of private corporations were passed into law in 2018 and continue to impact business owners in 2020. Here, we detail some of these changes and suggest some steps you may wish to take for your incorporated small business by December 31, 2020:
Income Splitting: Discouraging Income Distributions to Non-Involved Family Members
On Jan 1, 2018, the so called “kiddie tax rules,” which are also referred to as the “tax on split income” (TOSI) rules, were expanded. The rules were designed to eliminate the tax benefits of income splitting where the recipient of the income (a related family member such as grandparents, parents, children, brothers, sisters-in-law etc) has not made a sufficient contribution to the family business.
Background
The tax rate on business income earned in a corporation is generally much lower than the top personal marginal tax rate for an individual who earns business income; consequently, until income is withdrawn from a corporation as a dividend, there is a “tax deferral” in the form of personal taxes that are deferred until a dividend is paid. The deferral benefits for active business income from qualifying small businesses is quite significant – ranging from 32% to 42% in 2020, depending on the province or territory. For active business income (ABI) that is not eligible for the Small Business Deduction (SBD), the 2020 tax deferral ranges from 17.5% to 26.7%, depending on the province or territory. The rules pertaining to active or passive income are really about ensuring that these benefits apply only for operating businesses and are not repurposed to benefit passive investors (investing via holding companies) who would otherwise be facing higher personal marginal tax rates).
One additional strategy to consider, particularly if you are over the age of 40 and have significant T4 income, is the establishing of an individual pension plan.
Making a charitable donation is not only a great way to make an impact in your community, it is also a method of significantly reducing the personal tax you pay. The final day to make contributions to a registered charity in order to claim the donation tax receipt on your 2020 income tax return is December 31, 2020.
If you are looking for further advice, reach out to us at ClearWater Private Wealth, or email our President David Lush, CFP, directly ([email protected]) and let us guide you through the process. We are here to help and can assist you in maximizing your family’s financial future.
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