Jul 072015
 

Determining which account (Tax Free, Retirement, or Taxable) to hold different investment types in

Today’s post is targeted specificity at Canadians and assumes the reader is already familiar with the TFSA, RRSP, and regular taxable accounts.

There are two parts to every investment decision we make; the investment itself, and the type of account to hold that investment in. Asset allocation is important because we don’t want to put all our eggs in one basket. But asset location is also important because different types of investment incomes are taxed at different rates. Thankfully we can hold our investments in special tax advantaged accounts to shelter our profits so we don’t pay more tax than we have to. 😉

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In an ideal world all of our investments would be bought inside tax advantaged accounts such as a TFSA or RRSP. There’s little reason to use a non-registered (taxable account) if there is still contribution room remaining in our tax free or registered retirement accounts. However its possible to purchase more investments than what our tax advantaged accounts will hold. If that’s the case then investment income that is typically taxed at higher rates should take priority inside a TFSA or RRSP. So with that in mind let’s get down to the nitty-gritty. :)

Which Investment Vehicles to use: TFSA, RRSP, or Non-Registered

Where is the best place to put stocks, bonds, mutual funds, and ETFs? Should they go in an RRSP or a TFSA? There is no categorically correct answer but here are some general guidelines that I follow.

  • Use RRSPs for interest producing investments and U.S. dividend paying companies.
  • Use non-registered accounts for Canadian dividend paying companies and preferred shares.
  • Use TFSAs for everything else.

For a deeper look, below are two charts that go into specifics. The first chart shows how different types of investment income is taxed in different kinds of accounts for someone in the 31% marginal tax bracket. The second chart suggests the best accounts to buy different types of specific investments in. 😀

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Additional notes to consider:

  • If we hold U.S. dividend stocks in a taxable account we’ll pay the 15% U.S. withholding tax off the top. But we can claim a foreign tax credit on our tax returns to recover some or all of this amount. However we’ll pay tax at our marginal rate on the full amount of the U.S. dividend. The net result is that U.S. dividends held in a non-registered account will be taxed at the same rate as interest income.
  • Dividend income from U.S. dividend stocks in a Tax Free Savings Account (TFSA) is also subject to the 15% withholding tax, however this tax is non-recoverable. But the remaining dividend and any capital gains is not taxed.
  • Dividend income from U.S. stocks in an RRSP are exempt from the 15% withholding tax. But this only applies if we directly hold a stock or ETF traded on a U.S. exchange. If the U.S. stocks are held in a Canadian mutual fund or ETF, we will need to pay the unrecoverable 15% withholding tax on the dividends.
  • Keep in mind that although many investment incomes are tax efficient while being held in an RRSP, any money withdrawn from the RRSP or RRIF later on will be subject to income tax at the full marginal rate and could trigger claw-backs for income tested government benefits like OAS.
  • Tax efficiency should not be the only factor when deciding which account to put an investment into. Simplification of record keeping, personal financial situation, risk tolerance, and retirement goals all have to be considered.
  • For most intents and taxation purposes RESPs behave the same way as TFSAs. RRIFs and LIRAs behave similar to RRSPs.

Continue reading »

Mar 182015
 

The following article was contributed by a staff writer.

All Americans are well aware of what debt is and how it can negatively impact our lives. While the amounts and types may differ, when it comes to resolving debt issues, many opportunities are similar for everyone. However, there are special services and consideration for members who have served in our Armed Forces.

According to certain studies, members of the military often carry more personal debt than civilians, with at least a quarter of military personnel facing credit card debt of $10,000 or greater. Other types of debt most common among military veterans include auto loans, education loans, and mortgages. Fortunately, like civilians, service members have options when it comes to tax debt relief.

Debt consolidation is one of the more popular choices because it can combine all debt into one payment at a lower interest rate. Often it’s hard to make even minimum payments because of interest rates that are sky high. Mix that with potential late fees, and a minimum monthly payment may not even begin to cover the actual accrued debt. Military veterans also have the option of taking a consolidated loan from the VA, which offers reduced interest rates and more appealing lending terms to help pay down debt.

Another option is debt settlement. Some credit card companies and loan providers may consider a debt settlement amount that is lower than the overall total due in order to have it paid in a timelier manner. Calling on the help of an industry professional and the options they offer like Community Tax Services can help ease the burden of dealing with the IRS or other collecting parties on your own.

A debt relief company can help you negotiate lower amounts due on your debt, so that you can make payments more aligned with your current financial situation to allow you to achieve a clean slate. When looking into a debt settlement option, take a look at your income and be honest with how much per month you’d be able to pay. This will help when you discuss possible payment plans with a debt relief specialist.

When it comes to other tax services for military veterans, there are programs provided by the IRS to help assist with preparing and filing tax returns. The Volunteer Income Tax Assistance Program gives veterans who make less than $53,000 or suffer from a disability an opportunity to receive tax support from IRS-certified volunteers to make sure tax forms are filled accurately and on time. This can help with late fees, penalties, or audits.

These tax tips are helpful for military veterans who may be overwhelmed or just in need of a little help when it comes to filing tax returns or handling tax debt. There are solutions available for those who are willing to work towards the goal of paying off any money owed. Make sure to research other opportunities within your own city that may focus on helping members of our military during tax time.

Have you used a tax debt relief service? How did they help you? Would you recommend them to others?

Aug 262014
 

Looks like a merger is on the menu for Burger King :) It’s currently in talks to merge with Canadian company Tim Hortons and move its headquarters up here to Canada 😀 Tim Hortons is a quick service coffee chain that has a strong Canadian identity. Here’s a drive thru window at a typical Tim Hortons.

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Last year I blogged about buying some Tim Hortons shares and how investing in the coffee industry is the best idea ever! Thankfully my investment paid off because each share today is worth about 62% more than when I purchased them. Tim Hortons’ performance has beaten the overall stock market index in both Canada and the U.S. :)

If the acquisition is successful Burger King and Tim Hortons would continue to operate as individual franchises. You won’t find Timbits in your Whopper, and you won’t be offered fries with your coffee, haha 😆

The merger would benefit both companies. Right now Tim Hortons sells most of its coffee in Canada because it faces tough competition in the U.S. from Starbucks and Dunkin’ Donuts. But Burger King is already established in the U.S. and also has locations in Latin America and Europe, so Tim Hortons can use those valuable business channels to expand its brand awareness, and gain better access to global markets. Meanwhile Burger King would benefit from the high margin coffee business and also save money via tax inversion.

Tax inversion is when a U.S. company that has large overseas markets moves its main corporate office into a lower tax country. This allows the company to reposition itself as a foreign corporation so it can return foreign profits to stockholders without double taxation. This means if the merger is successful Burger King will get to pay a lower income tax, which will leave more after tax profits for its shareholders 😀

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Continue reading »

May 182014
 

I recently read an article written by the affable David Carrigg, a prolific Canadian columnist :) The article is about how a public insurance company (ICBC) made a botch of things and overcharged its customers by $39 million! Furthermore ICBC not only overcharged some of its clients, but it also undercharged other customers to the tune of $71 million total. Many B.C. residents became upset. When a Crown corporation mismanages money tax payers may be on the hook. And governments will often feel the pressure to raise taxes on the public to maintain fiscal order.

During this past year the Feds raised EI premiums. Quebec raised personal income taxes. B.C. increased its health care (MSP) premiums. Manitoba raised its provincial sales tax from 7% to 8%. And many Canadian cities like Toronto, Edmonton, and Vancouver (where I live) have raised local taxes :( According to the Fraser Institute, a public policy think thank, the average family earned $97,254 in 2013 and paid $42,400 in total taxes. In other words, 44% of what the average Canadian family makes is spent on various taxes. 14-05-tax-dollar-goes-Summary

Many people go out of their way to find discounts on stuff they want to buy. They shop wholesale to save on bulk items. They feel disappointed when they miss a sale on their favourite toothpaste. Yet they don’t even think twice about paying the full retail price for their taxes 😐 They can try to outperform the stock markets. They can cut coupons everyday. They can even work extra long hours for overtime pay. But they could probably save more money than all those strategies combined by simply lowering their total tax rate by ten percentage points or so.

This is why I operate my rental farm as a business instead of a personal property, invest inside tax sheltered accounts, and have debts with deductible interest so the more taxes I pay, the more I get back. It’s all for the purpose of saving taxes. Each year I calculate how much tax I pay as a percentage of my total income. I track this ratio and try to reduce it every year :) Like any other personal finance metric, once we start to track something regularly it will start to become something real to us that we can monitor, so that we can then set appropriate goals for it. But if we don’t track it, then we won’t know where to start or how low we should aim for. Last year my total taxes (income tax, sales tax, payroll tax, property tax, etc) represented about 30% of my total income. So I’m fourteen percentage points lower than average, but I think I can do better 😀 Who says doing taxes can’t be fun? 😉

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Random Useless Fact: 

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Mar 032014
 

I hope the Canada Revenue Agency doesn’t come after me for writing this post 😛 If too many people read this article then our government will never have a balanced budget lol. Since it’s that time of year again the topic I’d like to discuss today is income tax, and how rich people are able to dramatically reduce their taxable incomes because they understand that tax brackets are a moving target, and we all have the ability to manipulate our income tax rates as we see fit 😎

Let’s look at an example below. The following chart shows the income tax rates for B.C. Canada. There are only 6 cells we need to be aware of for the purpose of this article, which I’ve highlighted in yellow.

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Let’s say a hypothetical person named Tyler works full time at a retail bank branch and makes $43K a year there. Tyler also bartends a few nights a week. He has a small rental property, and some dividend paying stocks in a margin account. And finally Tyler has a small pasture of alfalfa in the boonies that he operates as a small business and is generating revenue via renting it to cattle ranchers.

Here’s a summary of all his annual incomes.

  • Bank employment T4: $43K
  • Bartending T4: $10K
  • Rental unit: $12K
  • Dividends T5: $5K
  • Small business income: $10K

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Total income = $80K

At first glance it appears Tyler is in the $75,213 to $86,354 income range, which should put him in the 32.50% marginal tax bracket according to the tax chart above. But not so fast. Sometimes we need to take a closer look at a situation before we can make an educated assessment.

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The more money we make the higher percentage of our incomes should go to the government right? But if that was true, why do some people who earn six-figures have lower tax rates than most middle class people? The answer is because those particular high-income earners are masters at manipulating their tax brackets! #likeaboss

Tyler believes he can use the same tools as the rich and reduce his taxable income in the eyes of the government. Let’s see how he does this.

Bartending $10K: Tyler contributes $10K to his RRSP to buy new investments. Since contributions are deducted from earned income this action essentially nullifies any income tax he owes from bartending 😉

-Rental unit $12K: Tyler’s insurance, mortgage interest, property taxes, and other expenses for the property work out to $12K a year which he can deduct from his rental income and break even. Who knew rental units that are cash flow negative have positive tax benefits? 😉

-Dividends $5K: Since most of Tyler’s dividend income comes from Eligible Dividends, he can claim the federal dividend tax credit. His final tax payable on his dividend income is only a small amount, which is easily neutralized by Tyler’s investment expense tax credit, since he bought some of his stocks on margin.

-Alfalfa business $10K: Tyler was smart enough to run his alfalfa pasture as a small business because businesses pay expenses first, and then pay taxes on any profit left over. After deducting all his expenses, like home office usage, traveling costs, and even interest charges on a business loan, his company will end the year with only a small profit, which will have an insignificant impact when added to his personal income 😉

So by using some clever financial maneuvers 4 out of his 5 income streams are no longer tax liabilities. Tyler is able to effectively lower his $80K of total income to just $43K of taxable income  which is a huge win because only taxable income is used to calculate how much taxes we actually pay, not gross income.

This effectively drops his marginal rate by TWO entire tax brackets from 32.50% to just 22.70%! #winning

So how much savings does a lower tax bracket translate to? Well by using a tax calculator we discover that at $43K of taxable income, Tyler only pays $6,600 in income tax. Which translates into a ridiculously low AVERAGE income tax rate of just 8.25% on the $80,000 gross he makes. Now compare that to Tyler’s boss, a senior manager who works in the same office as Tyler. He also makes $80,000 a year. But since his only income comes from his salary, his taxable income is the entire $80,000 amount, which means his marginal tax bracket STAYS at 32.50% and he has to pay about $17,700 in income tax before RRSP contributions/deductions. Wowzers 😯 #bigdifference!

Both Tyler and his boss are making the exact same upper-middle class income, yet look at the difference between the the 2 green numbers above 😕

Now that’s some SERIOUS tax savings!

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Doesn’t seem fair does it 😕 In fact some of you readers may be inclined to accuse Tyler of not paying his fair share of taxes 😡 But unfortunately life isn’t always fair 😐 This is the reality of our tax system. This is how some people can earn over $100K, and still only pay an AVERAGE tax rate of 10% or less.

So we can either adapt to make the tax system work FOR us like Tyler is doing, or we can accept the status quo like Tyler’s boss and complain about how life is unfair, taxes are too high, can’t seem to catch a break, blah blah blah 😛

Two roads diverged in a wood, and I— I took the one less traveled by, And that has made all the difference.” ~Robert Frost

The good news is we can all be like Tyler and take the less traveled path. Every single one of us has the power to choose how much taxes we pay to some extent 😀 The first step is to understand the difference between taxable income and gross income. The next step is to apply that knowledge.

Using tax deferred vehicles, leveraging to buy real estate, owning investments that pay eligible dividends, using effective tax credits, sheltering viable income generating operations in a small business, and diversifying our income streams in general, are all topics I’ve covered on this blog. These are just some of the many ways we can tip the tax scale in our favor (^_-) #SorryCRA

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Random Useless Fact:

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Be careful with super glue. If you accidentally get some on your hands you can remove it with acetone (fingernail polish remover.)