1. Contributing into RRSP to Reduce Tax Liability

RRSP contributions are tax deductible - they can be claimed as a deduction from income in the same year or may be carried forward and claimed as a deduction in a future year, depending on your expected income level. In the example noted above, if RRSP contribution of $5,000 is made by March 1, 2021, it can result in tax savings of $2,000 for 2020. For effective tax planning, you must consider not only your income level but also the income sources during the year to calculate the optimal amount of RRSP contribution for that year.

2. Income Splitting through Spousal RRSP

Splitting income with the low-income spouse can reduce taxable income and marginal tax rate of the high-income spouse. Spousal RRSP lets you contribute into your spouse’s RRSP, so that income, upon retirement, is split between the spouses and your combined taxes are lower than what you alone would have paid if the entire amount were received by you.

You must consider the following with a spousal RRSP:

• If you contribute into your spouse’s RRSP, you are the one who will claim this contribution as a reduction of your income in the same year or in a future year. This works out well if you were the high-income spouse.
• Your RRSP deduction limit is reduced by your contribution into spousal RRSP. For example, if your RRSP deduction limit for 2020 is $15K and you put $6K into spousal RRSP, you have the balance of $9K to contribute into your RRSP or leave unused.
• Your contribution into spousal RRSP must not be withdrawn for at least 3 years. If a withdrawal is made by the spouse within 3 years, it is added to your taxable income and not your spouse’s.
• You cannot contribute into your RRSP after the end of the year in which you turn 71. But you can still use your RRSP deduction limit to contribute into spousal RRSP until your spouse turns 71. This is particularly useful in reducing overall taxes if you are over 71 and still earning and your spouse is in a lower income tax bracket.

3. Using RRSP as a First-Time Home Buyer

Withdrawals from RRSP are taxable in all cases except two. One of these exceptions is the Home Buyers' Plan (HBP) that allows you to withdraw tax-free funds of up to $35,000 from RRSP to buy a home for yourself or for a related person with a disability. This opens up an effective tax planning opportunity, whereby you reduce taxes in each of the years that you contribute into RRSP and then access the accumulated funds ahead of your retirement and without any immediate tax implication. You have up to 15 years to repay the amounts that you have withdrawn from your RRSP under the HBP.

Unless you are a person with a disability or you are helping a related person with a disability buy a home, you must be a first-time home buyer to withdraw funds under the HBP. A first-time home buyer does not mean that it is the first ever home that you are buying as a principal residence. Instead, you qualify if, at any time in the previous four years, you did not live in a home that you owned or that your current spouse or common-law partner owned.

4. Using RRSP for Post-Secondary Education

Another way to withdraw tax-free funds from RRSP is through the Lifelong Learning Plan (LLP) whereby you can take out up to $10,000 in a year, and up to $20,000 in total, for your or your spouse’s full-time technical or vocational training or post-secondary education. LLP can be used toward part-time education if the student has a disability. Repayments to RRSP under the LLP is done over a 10-year period.

Contributing into RRSP for subsequently withdrawing those funds under LLP can be an effective tax planning tool for individuals who are currently in a low-income bracket and are pursuing further studies. For example, if you are a college student with a part time job, you can contribute into RRSP but can decide to forego deduction from your taxable income in the current year since your marginal tax rate is already low. You can carry forward the un-deducted contribution and use it in a later year when your income level has gone up, while in the meantime having used the LLP to partially fund your education.

5. Final RRSP Contribution

The final RRSP contribution must be made up to December 31 of the year in which you turn 71, by which time RRSP must be either withdrawn or transferred into RRIF or an annuity. If you are working during the year when you are 71, you will have RRSP deduction limit for next year, but you will not be allowed to contribute into your RRSP at that time. A tax planning opportunity arises here - you can estimate your RRSP deduction limit for next year and make a final contribution into RRSP in December of the year in which you turn 71 before it is converted into RRIF or annuity. CRA will charge 1% penalty on the over-contribution for one month only, but you will potentially have a larger tax saving by deducting RRSP contribution from your income for next year.

Choose Wisely

Tax planning cannot follow a ‘one size fit all approach’. You need to be careful in deciding which tax planning strategy works best for you and choose the optimal combination that can help reduce taxes. The options that have been discussed here are meant for general information only, and you must obtain professional advice in deciding which tax planning strategy would work in your particular situation. 

1. Contribute into a Registered Retirement Savings Plan (RRSP)

Putting money into RRSP gets you a deduction from the total income that lowers the amount of tax payable for the year. Income received within RRSP remains tax-free, but tax is applied when you withdraw funds from RRSP. Essentially, RRSP is a retirement savings vehicle since it allows you to defer taxes on contributions into RRSP and on your earnings until retirement, at which time you pay tax based on the applicable marginal rate. Most people are usually in a lower tax bracket after retirement; hence, the tax rate is likely to be lower than what it would be now. You can also use spousal RRSP for tax planning when the spouses are in different tax brackets.

2. Invest into a Tax-Free Savings Account (TFSA)

TFSA provides a tax-free option to earn investment income, such as interest, dividends, and capital gains. Money deposited into a TFSA can grow on a tax-free basis, and no tax is payable when you withdraw that money or your earnings. TFSA provides an effective tax planning tool for low- and modest-income earners since they can earn investment income within TFSA without reducing or becoming disqualified for government benefits and credits that are linked to their income level. Another way TFSA can be used in tax planning for individuals is for a high-income spouse to gift money to a low-income spouse to contribute into the spouse’s TFSA or for a parent to gift money to a child who is at least 18 years old for contributing into the kid’s TFSA.

3. Give Charitable Donations

Giving is a joy in itself! You can double the joy by claiming charitable donation tax credit to reduce your tax liability. The federal tax credit is 15% on the first $200 of donations to registered charities and then at a much generous level of 29% on additional donations in a year. The tax credit can reach 33% if you are in the highest tax bracket. In tax planning for individuals, unused charitable donations may be carried forward for up to five years so that the tax credit can be claimed in a later year when taxable income is higher than usual. You can also share charitable donations with your spouse to enable the higher-income spouse to reduce the tax bill.

4. Income Splitting

Splitting income with the low-income spouse can reduce taxable income and marginal tax rate of the high-income spouse. Income splitting needs to be approached with caution to ensure that tax reduction arrangements are not subject to tax on split income (TOSI) rules, attribution rules or otherwise inconsistent with the intent of law. Despite the scrutiny, certain income splitting opportunities remain available for the benefit of taxpayers. These include the spousal RRSP and TFSA arrangements noted above as well as the opportunity to transfer dividend income to a spouse, lending money to spouse for investment, and pension income splitting. Each arrangement comes with its set of rules and caveats that must be considered for effective tax planning.

Choose Wisely

The above-mentioned ways are just a few of the many different techniques one can use for effective tax planning. Tax planning cannot follow a ‘one size fit all approach’. You need to be careful in deciding which tax planning strategy works best for you and choose the optimal combination that can help reduce taxes. Depending on your circumstances, it may be useful to obtain professional advice for tax planning that caters to your specific situation.

J-MAK CPA team