Welcome back to the blog!
In addition to working with clients on investment and wealth management, I write a blog on tax tips and tidbits and share other articles that I think will be of interest.
In this edition, I’ve summarized seven year-end tax planning strategies for investors to consider that may yield meaningful tax savings.
If you hold securities with unrealized losses in non-registered investment accounts, consider selling the securities to offset capital gains in the year or to carry back to apply against net capital gains in one of the three preceding years. In order for the loss to be available, assuming a two day settlement, the sale transaction must be initiated on or before December 29th, 2021.
In the event that you own securities in a foreign currency, the gain or loss may differ from what you anticipate once you take the exchange rates into account. Specifically, you must calculate the cost base using the Canadian exchange rate in effect on the day of purchase as well as the day of the disposition of the security to correctly determine whether you have an unrealized gain or loss for Canadian tax purposes. Here’s a quick illustration and example…
- Buy a security for $10 USD when the exchange rate is at par, so your cost is also $10 CAN
- Security declines in value to $9 USD and you think you have an unrealized capital loss, however, with the exchange rate now closer to $1.25 your proceeds are $11.25 CAN, actually triggering a capital gain, whoops!
It is important to ensure that the sale of a security fits within your overall investment objectives when considering tax-loss selling. If the investment still has strong fundamentals and there is a desire to continue to own it in your portfolio, you need to be aware of the superficial loss rules. These are a complex set of tax rules that can potentially deny the loss when the security is repurchased within 30 days by you or a person affiliated with you, which can include your spouse, a company that either of you control, or even a trust.
If in doubt, ask your advisor prior to repurchasing a security sold at a loss.
Capital gains deferral
In contrast to tax-loss selling, you may be approaching the end of the year with significant unrealized gains in your portfolio, particularly in light of the market performance over the last couple of years. Here, you may wish to defer triggering capitals gains for a couple of reasons.
- Next year, you expect to be in a lower marginal tax bracket as a result of a reduction in income, perhaps the result of a transition to retirement
- Triggering the capital gains this year means that the tax payable associated with the capital gains is due at the end of April next year, whereas if the gains are deferred until January, the tax is not due until May 1st, 2023, so in effect, you get a 12 month tax deferral
Similar to the tax-loss selling, the investment merit of the security in question needs to be considered in conjunction with the tax benefit of the capital gains deferral. In other words, there might be a worthwhile reason to sell the security today in spite of the tax benefit of deferring the sale to a later date.
The contribution deadline to be able to claim a tax deduction this year is March 1st, 2022, however, contributing early will generally maximize the tax-deferred growth, thereby helping to increase savings for retirement.
If you turn 71 this year, you must convert your RRSP to a RRIF prior to December 31st, 2021, so this is generally your last kick at the can to make a contribution to your RRSP if you have available contribution room remaining.
So what if you turn 71, have maximized your RRSP contributions already and have earned income in the year?
Well, then you’re in luck, as there is an often forgotten RRSP contribution such that you may wish to consider one final contribution before your RRSP matures. Technically, this RRSP contribution room is not available until next year so this amount is considered an excess contribution at the time the contribution is made. It will be subject to an over-contribution penalty tax of 1 percent per month of the excess amount until January 1st, 2022, so it is best to make this contribution at the end of the year and only after consulting a professional advisor.
Instead of making the forgotten contribution and dealing with the penalty tax, if you have a younger spouse, you can simply make this contribution next year to a spousal RRSP for the spouse’s benefit.
Finally, if you have a younger spouse and your RRSP matures, you can also opt to set the minimum RRIF withdrawal based on your spouse’s age instead of your own, decreasing the amount that is taxable.
The annual contribution limit this year is $6,000 and the cumulative limit since inception is $75,500.
If you make a withdrawal from your TFSA account, in the subsequent year, an equivalent amount of TFSA contribution room is reinstated. Therefore, if you are planning a TFSA withdrawal next year, consider withdrawing the funds instead by December 31st, 2021 so that you will be able to re-contribute the amount next year.
In the event of an over-contribution, either as a result of re-contributing a withdrawn amount in the same year without having adequate contribution room or through simply making excess contributions, penalties will result.
Now although the CRA tracks your TFSA contribution room, this information is only provided to them once per year, so their records will not necessarily be up to date and reflective of contributions made throughout the year.
We often recommend that investors maintain a single TFSA account at one institution so that this institution can keep track of the available room annually as well.
Timing of mutual fund purchases
The only way to capture the full permanent returns of the markets is to ride out every day of their temporary declines.
Though it is simply not possible to consistently time the market, it is important to consider timing with respect to mutual fund purchases as we approach the end of the year. A mutual fund is purchased at its net asset value and this includes accumulated income and gains that have not yet been distributed. These distributions are fully taxable on receipt in a non-registered account, even though the mutual fund was purchased with after-tax dollars.
In order to avoid a punitive tax distribution, the purchase of a mutual fund can be delayed until after the distribution date such that the investment is purchased without the accumulated income and gains.
Towards the end of the year, we review estimated distributions for each mutual fund to ensure that potential distributions and the tax implications are considered for clients when investing in non-registered accounts.
The opportunities for individuals, corporations, and trusts to income split are few and far between these days, however, one relatively simple method that is still available is a prescribed rate loan to split investment income.
If you are in a high tax bracket, you may wish to have investment income taxed in the hands of a spouse or child who are in a lower tax bracket. Unfortunately, this isn’t quite as easy as gifting the funds or securities to a family member as the investment income maybe be attributed back to you, thereby not accomplishing the objective.
So how do you do this legitimately and avoid attribution?
It is simple, lend the funds to the family member in a lower tax bracket at the prescribed interest rate currently set at 1 percent. Once the loan is established, the interest rate is locked in and remains in effect for the duration of the loan, so potential concerns about future rising rates have no impact.
Next, the family member invests the loaned funds and any interest, dividends or capital gains are taxed in that family members hands at their lower marginal tax rate. In the event that the family member has no other income, up to approximately $50,000 of dividends from Canadian public companies can be received tax free.
The 1 percent interest must actually be paid annually by January 30th of the following year each year the loan is in effect - it is deductible to the family member paying and taxable to the family member receiving it.
I think we all have a lot to be thankful for, so I’ll end with a final tip that also benefits organizations in need.
A donation to a registered charity is one of the best ways to significantly reduce the personal tax that you pay while benefiting a cause that is meaningful to you and your family. The final day to make a contribution to the claim the deduction on your 2021 income tax return is December 31st, 2021.
Instead of making a cash donation, you can consider gifting publicly listed securities or mutual funds in-kind to sweeten the tax benefit. You receive a donation receipt equal to the market value of the security at the time of the donation and are not subject to tax on the realized capital gain as you would be if sold you the securities and donated cash.
In B.C., a personal donation in excess of $200 results in a tax credit of at least 45.8 percent, a significant savings. A corporate donation, in some instances, can result in an even greater tax savings.
If you have questions on any of the above tips and tax planning strategies, I’d be happy to chat further.
I can be reached at firstname.lastname@example.org or 604.981.6681.
This blog and article may contain strategies, not all of which will apply to your particular financial circumstances. The information in this article is not intended to provide legal, tax or insurance advice. To ensure that your own circumstances have been properly considered and that action is taken based on the latest information available, you should obtain professional advice from a qualified tax, legal and/or insurance advisor before acting on any of the information in this article.
This information is not investment advice and should be used only in conjunction with a discussion with your RBC Dominion Securities Inc. Investment Advisor. This will ensure that your own circumstances have been considered properly and that action is taken on the latest available information. The information contained herein has been obtained from sources believed to be reliable at the time obtained but neither RBC Dominion Securities Inc. nor its employees, agents, or information suppliers can guarantee its accuracy or completeness. This report is not and under no circumstances is to be construed as an offer to sell or the solicitation of an offer to buy any securities. This report is furnished on the basis and understanding that neither RBC Dominion Securities Inc. nor its employees, agents, or information suppliers is to be under any responsibility or liability whatsoever in respect thereof. The inventories of RBC Dominion Securities Inc. may from time to time include securities mentioned herein. RBC Dominion Securities Inc.* and Royal Bank of Canada are separate corporate entities which are affiliated. *Member-Canadian Investor Protection Fund. RBC Dominion Securities Inc. is a member company of RBC Wealth Management, a business segment of Royal Bank of Canada. ® / TM Trademark(s) of Royal Bank of Canada. Used under license. © 2019 RBC Dominion Securities Inc. All rights reserved.