Tax and Retirement Planning

Tax and Retirement Planning

CONTENT AREAS

  • How Does the Canadian Taxation System Work?

  • What Are the Main Pension Plans in Canada?

  • What Are Tax Deferral Plans?

LEARNING OBJECTIVES

  1. Differentiate among ways that interest income, foreign dividends, Canadian-source dividends, and capital gains are taxed.

  2. Identify and describe the features of the government pension plans available to Canadian citizens.

  3. Describe and differentiate between the most common employer-sponsored registered pension plans.

  4. Describe the features of registered retirement savings plans (RRSP) and calculate the annual contribution limit to an RRSP.

  5. List and describe the features of tax-free savings accounts (TFSA).

  6. Describe the features of registered education savings plans (RESPs) and explain how RESPs can be enhanced with Canada Education Savings Grants (CESGs).

KEY TERMS

  • Canada Education Savings Grants (CESG)

  • Canada Pension Plan (CPP)

  • Capital gain

  • Capital loss

  • Career average plan

  • Carry forward

  • Contribution in kind

  • Contribution room

  • Deemed disposition

  • Defined benefit plan

  • Defined contribution (money purchase) plan

  • Dividend tax credit (DTC)

  • Earned income

  • Final average plan

  • Fiscal year

  • Flat benefit plan

  • Life annuity

  • Life income fund

  • Locked-In Retirement Account (LIRA)

  • Locked-in RRSP

  • Marginal tax rate

  • Money purchase plan

  • Old Age Security (OAS)

  • Over-contribution

  • Pooled Registered Pension Plan (PRPP)

  • Québec Pension Plan (QPP)

  • Registered Education Savings Plan (RESP)

  • Registered Pension Plan (RPP)

  • Registered Retirement Income Fund (RRIF)

  • Registered Retirement Savings Plan (RRSP)

  • Spousal RRSP

  • Tax-Free Savings Account (TFSA)

INTRODUCTION

  • The chapter emphasizes the significance of understanding retirement planning and tax implications for investment recommendations.

  • Knowledge of retirement plans is critical for mutual fund sales representatives.

  • Differentiation of tax treatment for various income types is essential for effective retirement planning.

HOW DOES THE CANADIAN TAXATION SYSTEM WORK?

  • Important to understand how taxes impact returns on investments.

  • Tax planning should be integrated with financial strategy.

  • Key considerations:   - Focus on after-tax income or return.   - Tax planning should not overwhelm financial management or become the sole objective.

  • Tax avoidance is legitimate through:   - Utilizing allowable deductions.   - Converting non-deductible expenses to tax-deductible ones.   - Postponing income receipt.   - Income splitting with family members.   - Selecting investments for a better after-tax return.

THE INCOME TAX SYSTEM IN CANADA

  • Imposed by federal statute (the Income Tax Act, ITA) with provincial statutes influencing resident taxation.

  • The federal government collects provincial taxes except for Quebec and Alberta.

  • Taxpayers must calculate income annually, with individuals using the calendar year and corporations selecting any fiscal year.

CALCULATION OF INCOME TAX

  • Involves:   1. Calculating all sources of income.   2. Making allowable deductions.   3. Calculating gross tax payable.   4. Claiming tax credits.

  • Types of income include:   1. Employment Income: Taxed on gross receipt basis; minor deductions allowed.   2. Capital Property Income: Includes income from stocks, bonds, mutual funds.   3. Business Income: Taxes net income; includes self-employment income.   4. Capital Gains and Losses: Result from sale of capital property; gains taxed upon sale.

CALCULATING INCOME TAX PAYABLE

  • Basic tax rates for 2024:   - $55,867 or less: 15%   - Over $55,867 to $111,733: 20.5%   - Over $111,733 to $173,205: 26%   - Over $173,205 to $246,752: 29%   - Over $246,752: 33%

  • The concept of the marginal tax rate is essential for understanding the impact of additional income.

TAXATION OF INVESTMENT INCOME

  • Revenue types from investments taxed differently:   1. Interest Income: Reported on an accrual basis; taxed like regular income.   2. Dividends from Taxable Canadian Corporations: Preferential tax treatment; grossed-up 38% with a federal DTC of 15.02%.
      - Example: $300 dividend leads to a reported income of $414, yielding a tax of $45.46 after credits.   3. Capital Gains: Only 50% taxable; example of $300 gain reports as $150 taxable.   4. Foreign Dividends: Generally taxed like regular income with restrictions.

MINIMIZING TAXABLE INVESTMENT INCOME

  • Shifting from interest to dividend-paying Canadian stocks can reduce taxes.

  • Comparison at different marginal tax rates demonstrates varying impacts of interest, dividends, and capital gains on taxes.

CASE STUDY: TED AND JUSTINE

  • Financial advisor reviews portfolio and tax implications related to investments.

  • Recommendations for tax optimization include using TFSAs to shelter capital gains and dividends.

TAX-DEDUCTIBLE ITEMS RELATED TO INVESTMENT INCOME

Carrying Charges

  • Allowable deductions include:

  • Interest paid for earning investment income.

  • Fees related to investment advice.

  • Fees for investment administration.

Borrowed Funds

  • Interest with specified criteria can be deducted; exceptions apply.

WHAT ARE THE MAIN PENSION PLANS IN CANADA?

Types of Pension Plans

  • Government Pension Plans: CPP, QPP, OAS.

  • Employer-Sponsored Plans: Include regular contributions from both employers and employees.

GOVERNMENT PENSION PLANS

  • Contribution to CPP or QPP is automatic; pensions based on contribution years are irrevocable.

  • OAS has residency requirements and may be subject to a clawback based on income.

EMPLOYER-SPONSORED PLANS - REGISTERED PENSION PLANS (RPP)

  • Two types: Defined Benefit Plans (DBPs) and Defined Contribution Plans (DCPs).

  • DBP benefits are predetermined; DCP benefits depend on investment performance.

DEFINED BENEFIT PLANS

Types:

  1. Flat Benefit Plans: Flat pension per service year.

  2. Career Average Plans: Based on average earnings throughout the career.

  3. Final Average Plans: Based on the highest earnings over a specific period.

DEFINED CONTRIBUTION PLANS

  • Contributions vary; benefits at retirement depend on fund performance.

  • Contribution limits for 2024: $32,490 (indexed).

WHAT ARE TAX DEFERRAL PLANS?

Registered Retirement Savings Plans (RRSP)

  • Contributions are tax-deductible; income grows tax-free.

  • Types: Single Vendor and Self-Directed RRSPs with various controls in investments.

Contributions to an RRSP

  • Limits based on earned income; over-contributions and penalties discussed.

Spousal RRSPs

  • Allows contributions while claiming deductions for the contributor.

Termination of RRSPs

  • Required by age 71 with various withdrawal options.

TAX-FREE SAVINGS ACCOUNTS (TFSA)

  • Introduced in 2009, ideal for tax-free income during an individual’s lifetime.

  • Flexible contributions and withdrawals without penalties.

  • Restrictions per annual limits and provisions for rolled-over contribution room.

REGISTERED EDUCATION SAVINGS PLANS (RESP)

  • Tax-deferred; contributions not tax-deductible with a lifetime max of $50,000 per beneficiary.

  • CESG provides matched contributions to stimulate savings.

SUMMARY

  1. Differentiate taxation of various income types.

  2. Identify features in government pension plans.

  3. Describe employer-sponsored plans and their characteristics.

  4. Explain RRSP characteristics and contribution limits.

  5. Describe TFSA features.

  6. Elaborate on RESPs and CESGs.

REVIEW QUESTIONS

  • Aimed at reinforcing knowledge from the chapter.

FREQUENTLY ASKED QUESTIONS

  • Addressed in online resources for clarity on chapter topics.