Tips for a Tax-Efficient Tax Season
Many Canadian investors scramble to find last-minute strategies to lower their tax burden right before the deadline. However, the truth is that the most effective tax-saving strategies are not concocted in the eleventh hour but are prudently implemented throughout the year.
Tax efficiency in investment portfolios is a year-round commitment. In this post, we’ll delve into the importance of tax efficiency and provide helpful tips to lower your tax burden.
The Importance of Tax Efficiency
According to a Morningstar study titled “When Bad Taxes Happen to Good Funds,” the average equity mutual fund lost 1.48% of returns to taxes annually. This concept is called “Tax Drag.”
Three Tips for a Tax-Efficient Strategy
1. Maximize Contributions to Tax-Advantaged Accounts
Building significant savings in RRSPs and TFSAs provides flexibility. For instance, supplementing RRIF withdrawals (fully taxable) with TFSA withdrawals (tax-free) allows you to manage your marginal tax bracket and avoid OAS clawback.
2. Consider Income Splitting
Split eligible pension income with your spouse to transfer tax liability from a high earner to a low earner. "Pension income" isn't just DB pensions; for those 65+, it includes RRIF and LIF withdrawals.
3. Asset Location
This refers to mindfully placing investments in specific accounts:
- Non-Registered Accounts: Best for Canadian dividend-paying equities (to use the Dividend Tax Credit).
- RRSPs/TFSAs: Best for interest-bearing investments or foreign dividends (which are fully taxable otherwise).
By proactively optimizing your investment strategies, you can enter tax season with confidence and peace of mind.