Contrary to conventional wisdom (and some advice from accountants and tax software), getting your year-end taxes to be as low as possible is not necessarily good tax planning. It looks good on paper, but to truly be tax efficient, you need to think beyond this year.
Here are three examples of short-term tax planning strategies that may cost you thousands in lifetime taxes:
1) Refusing to withdraw money from your RRSP until you are forced to at 71.
In many cases, people don’t take money out of their RRSP in their 60s because it will increase their tax bill in that year. All this does is defer large taxes for the future. If your income now is lower than it will be after you are 71, start withdrawing from your RRSP. You will be taxed at a lower rate. In addition, you can prevent your income from going beyond the Old Age Security threshold. Finally, you will prevent your estate from taking a massive tax hit as your remaining RRIF balance is taxed as “income earned in one year” upon death.
2) Always putting off taxable capital gains as long as possible.
Again, if you are in a low-income situation in a particular year, it may make sense to take the capital gain now, and not put it off.
As an example, if you have a $10,000 gain on a stock and sell it, your capital gain tax could be $2,300 (23% in Ontario) if the sale takes place in a year when you are in the top marginal tax bracket. If, instead, you are in a much lower tax bracket in a particular year, the tax bill on the same stock sale may be $1,200 (12% in Ontario). If your income fluctuates, save on capital gain taxes this way.
3) Always getting the tax refund from your RRSP contribution.
It doesn’t always make sense to claim an RRSP contribution in a low-income year – even though it will always lower your current tax bill. Let’s say you make $35,000 this year, but next year you expect to make $90,000. You can still make an RRSP contribution to get the tax sheltering this year, but it is better to carry forward the deduction until the next year. In this example, you could get an extra 23 per cent refund by waiting one year to claim the deduction. That is a pretty good return in any year.
In all of these cases, it is important to understand your long-term financial picture instead of trying to simply lower your yearly tax bill. To get a sense of your long-term tax bill, try out the free Tridelta Retirement Tool. It calculates the amount of taxes you will have paid over your lifetime based on a few simple questions.