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Reader Mail: How can the bread winner reduce taxes?

I received a reader question from Blake the other day about how a sole income earner can reduce their taxes.  Here is the question:

I was thinking, have you written about the ability to pay less taxes? For example, I'm investing a decent amount of money each year in registered/non-registered and life insurance plus my work pension plan. I have a new family and I'm the sole earner but I'm not aware of areas of reducing taxes because of my income I'm sending much of it to Ottawa.  Just curious what avenues someone has to discuss lowering the amount of taxes they pay as opposed to going to H&R block each spring.

 There aren't a lot of tax loop holes for a regular corporate Joe to reduce their taxes besides using RRSP's.  However, I have written numerous articles about different methods of reducing taxes for a single bread winner:

  1. Use Spousal RRSP's – the goal is for your and your wife to retire with the same size nest egg.
  2. Make sure to take advantage of all your child care tax credits. Check out a case study that I wrote about.
  3. When you get more comfortable with investing, consider investing a small portion of your portfolio in Flow Through Shares.  Here is another article on Flow Through Share examples.
  4. If you have any interest bearing investments like GIC's etc, make sure that they are held within your RRSP.
  5. This is not really about tax savings, but check out Ed Rempels article about Universal Life Insurance.  If you are currently using it, you may want to reconsider.
  6. If you are comfortable with leverage, consider using The Smith Manoeuvre strategy.  This is where you can convert your mortgage into a tax deductible investment loan.

Anything to add to help Blake out?

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FT About the author: FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.

{ 18 comments… add one }
  • The Financial Blogger August 14, 2007, 8:02 am

    I see two other things. The investment loan (which might not suits Blake situation depending on his tolerance to risk) and the Debt Swap.
    I previously wrote a guess post here as a guest writer and finish the post with a part two on my blog. Here are the links:
    https://www.milliondollarjourney.com/?s=debt+swap

    http://www.thefinancialblogger.com/debt-swap-part2/

    Blake, as you already have non-registered investments, your financial situation will not changed and there is not more risk involve (the debt swap implies you have already debts anyway!). You will only save more money in taxes!

    Hope this helps!

  • FrugalTrader August 14, 2007, 8:32 am

    Great point FB, how could I forget about the Smith Manoeuvre! Adding it to the article now.

  • FourPillars August 14, 2007, 11:57 am

    I would argue that leveraged investments (aka Smith Manoeuvre) does not lower your taxes which is Blake’s goal.

    This might be just semantics, but with leveraged investing you are really just lowering the cost of the leveraging (ie interest) by using a tax write-off which isn’t really the same thing.

    He mentions having an rrsp – if he’s not maxing it out then that’s the easiest way to lower his taxes.

    Mike

  • The Financial Blogger August 14, 2007, 1:15 pm

    FP,
    I do not think that people should leverage because of the fiscal advantages. It is just an added value permitted by our Government. As you know, the goal with leveraging strategies is to produce a better yield than the interest you pay. This should be regardless if the interest rate is deductible or not.

    Therefore, I think it should be counted as it does decrease your taxes.

  • Blake August 14, 2007, 1:24 pm

    Thank you for your comments.
    I do max out my rrsp’s but because my company pension contributions are so high there is very little room to add, $1500-$2000.

    I have taken advantage of RESP. Because I don’t have room in my rrsp’s a spousal rrsp won’t work. Also with income splitting in retirement is it really necessary now?

    I had “heard” that you can reduce your taxes by setting up RRSP’s in your childs name, you add to your RRSP’s then transfer them to the child. Obtaining the tax credit, then cashing out the child’s portion paying a lower tax. Seems a bit odd to me.

    Thanks for everyone’s comments & contributions, this is a fantastic forum.

  • Traciatim August 14, 2007, 1:58 pm

    Why not set up an loan to your spouse for investing at some low interest rate so that your investment income will come in in your spouses name while she pays you tax deductable interest. You would probably have to sit down and do the math but all of your non-registered investments could be done this way and reduce your tax bill since all the investment income would be in their name.

  • Gates VP August 14, 2007, 2:30 pm

    Wow Blake, your pension is so high that you only have a couple of grand available? Is this monthly or annually? 2k/month is still pretty huge, that’s 24k/year plus pension amounts. 2k/year is pretty tiny (but man how big is your pension, like 15%?)

    The other, oft-forgotten investment is you!

    Higher education usually comes with tax breaks and is also a great differentiator over the course of a long career. This means that not only do you get a tax break on the money you spent, but you’re increasing the value of your future time which means more money in the future.

    Last I checked, part-time students get Tuition fess and $200/month tax free, “off the top”. You may not net a benefit, but you may be close to breaking even on the deal, which is like free training.

  • FourPillars August 14, 2007, 3:49 pm

    FB – technically leveraging does lower your taxes but it costs more money in interest.
    Using that logic, donating money to charities and political parties should also be on the list since they lower your taxes also.

    Labour Sponsored Funds also have extra tax advantages which don’t even come close to making up for the fact that they are horrible investments.

    Mike

  • Blake August 14, 2007, 3:57 pm

    I’m still trying to understand my pension to be honest, but my contribution is 5-6% and then there is the employer contribution. What’s left is around 2,000 at the end of the year.

    Once again, thanks for the responses.

  • The Financial Blogger August 14, 2007, 4:07 pm

    FP,
    This is an interesting point, however, charity donations do not grow over time ;-) After several years, your interest should be covered by your investment income.
    However, it is true that this measure hurts your monthly cash flow as opposed to other tips mentioned.

    Blake/Gates, I have the same problem with my pension. I have about 2-3K a year left for my rrsp contribution. I guess it comes with the fact that my future pension income is defined which is much better than defined contribution. I would definitely suggest you do a debt swap as a first step.
    Cheers,
    FB.

  • FourPillars August 14, 2007, 5:51 pm

    FB – true enough.

    By the way I re-read your debt swap articles and now that I can see an actual example where it can be applied (Blake’s situation) it looks quite interesting.

    The capital gains in his current non-reg stocks would have to be factored in as well – ie if the acb is very low then it might not be worth doing.

    Mike

  • Gates VP August 14, 2007, 6:07 pm

    FB/Blake;

    If you make 50k/year with a 6% pension contribution you’re already putting aside 3k/year. Given your numbers that means that your boss is likely matching the number (another 3k) and CRA is limiting your contribution to 6% (or 3k) for a total of 18%/year (the current max).

    It’s worth noting here that you’ve effectively maxed out your retirement savings! That’s 9k out of 50k every year! If you’re making more than this, then of course maxing out retirement saving means that you have even more money going into the savings.

    If you can max out retirement savings with 3k/year of contributions and not “feel the pain”, then you’re doing really well. Once you’ve maxed out the spousal RRSPs, then it may be time to take a different tack and start saving for a rental home or some other line of potential income.

  • WhereDoesAllMyMoneyGo.com August 14, 2007, 11:43 pm

    To further the point on reducing taxes and investment loans – I’m just writing a series on my blog right now about leverages – I haven’t gotten to the article in the series which is the culmination yet, but it involves figuring how much your RRSP contribution is and dividing that by your marginal tax rate (to see how much of an interest-only loan you need in terms of the interest payments) – then taking that number and dividing by the prime rate to see how much the loan is.

    Example:

    RRSP contribution will be $10,000 for the year.

    $10,000 / 50% MTR = $20,000 in interest payments (to produce $10,000 refund to be put into RRSP)

    $20,000 in interest payments / 6% prime rate = $333,333 in a leverage.

    So your out of pocket is $20,000 for the year, but you get $10,000 back for writing off the interest, and then another $5,000 back for making the RRSP contribution.

    You can get it all done in one year by applying for an RRSP loan with a 90 day deferred payment to beat the deadline so you have the $15,000 coming to you starting after the first year.

    So you pay $20,000 out of pocket, get $15,000 back in refunds. Closer to $14,000 in reality, but using 50% for math’s sake.

    That’s a big honking loan, so you want to wait for a correction and to be real sure, you should go with a loan half that size for a $10,000 interest payment/year, and PAC the other $10,000. If the market goes down again, you can trigger the “other half” of the $333,333 loan and “double down” as it were.

    If you did a straight PAC and arrived at Value X after 15 years and assume this to be 100% confidence baseline for a monte carlo simulation, that the full on leverage with piggy-backing refund will provide roughly 1.7x in value, with 76% confidence. BUT by going the “hybrid” method (half leverage and half PAC for 5 years, or until market correction) the numbers become 1.5X and 98% confidence.

    If market growth is very high for the first 5 years you collapse the leverage and start over (locking in your gain).

    I will post in detail with monte carlo support on my website – probably 3 or 4 more articles to go in that series before I get to that concept though.

    Cheers,

    Preet

  • Man From Atlantis August 19, 2007, 10:44 am

    Is there a way to attach an attachment?

    Blake:

    Consider leveraging. If you compare RRSPs to leveraging you will see that you get the same tax deductions and your capital accumulation will be about the same. The difference is in taxable income. Your leveraged account will give you at least twice the after tax income in retirement. Plus, you have reduced your risk of clawbacks, may recieve more tax credits and can maybe plan for some government benefit programs.

    Also consider only making RRSP contributions up to the point of employee matching. Save your RRSP room for the day you sell your leveraged investment. Then make a good sized RRSP contribuion with the taxable portion.

    Remember that an RRSP is ok for income but lousy if you want to make a lump sum purchase (Car/trip)in retirement.

    The leverage will give you the tax deduction. Can you get enough of a deduction to drop you to the next Marginal Tax Rate – That is your aim.

  • Ed Rempel August 19, 2007, 11:59 pm

    Blake,

    Leveraging or the SM is your best bet. You must have a governement of teacher’s pension. They usually leave you only about $2,000/year of RRSP room. It’s a generous pension but leaves you little extra.

    Preet’s interesting analysis shows that you can use leverage to get a similar but greater benefit than RRSP’s. You get tax refunds now and can defer most or all tax on income until after you retire. Leveraging has advantages though, since you can have far higher amounts invested by paying interest only than with a similar RRSP contribution.

    We have quite a few clients with pensions like yours. Leverage is a perfect way for them to invest more, get tax refunds now, and have some tax-efficient money to access after retirement.

    Your other option may be to look for ways to split income. You do have an opportunity if you spouse has no income. If your only income is your salary, though, you can’t really split that.

    If you leverage or do the SM, you should claim the deduction and any investment income, but you can systematically move the amount of any taxable investment income into your spouse’s name. This can allow you to build up investments in your spouse’s name to split future income.

    Ed

  • Sanjay Varma February 18, 2008, 5:15 pm

    “I had “heard” that you can reduce your taxes by setting up RRSP’s in your childs name, you add to your RRSP’s then transfer them to the child. Obtaining the tax credit, then cashing out the child’s portion paying a lower tax. Seems a bit odd to me.”

    The above as mentioned in Blake’s post, is it possible to invest in your RRSP under your child’s name, if yes how does this actually work?

    Have been contemplating on SM but haven’t reached the comfort level yet. I am in a similar situation like Blake wherein after pension contributions very little room is left for RRSP contributions, same goes for my wife, so looking for ways to maximize on this and minimize taxes.

    I have been following this blog for long and have got enlightened time and again by articles and suggestions made by various participants.

    Thanks,

    Sanjay

  • bob June 2, 2010, 3:56 pm

    Be very cautious with the last post. It sounds to me like:

    1) the poster doesn’t really understand what an RRSP is. RRSPs need not consist of mutual funds. And clearly doesn’t understand the tax implications of investing inside and outside of Registered plans.

    2) 10% annual fixed rate? — you’re dreaming unless it is a scam or you have a different definition of “fixed” than most people do.

    3) MIC’s are RRSP eligible . . .

  • bob June 2, 2010, 4:29 pm

    Also, despite what Reena claims, MICs do not hold “real hard assets – land”. In fact, they hold mortgages secured against real property.

    As this article points out, this distinction is significant in two ways:

    1) mortgages do not appreciate in value like real property does
    2) properly structured mortgages are secure fixed-income investments

    I’m not sure why Reena feels the need to not hold her MIC’s in an RRSP, as they are eligible for registered tax treatment. By not holding MIC in RRSP the income is treated as interest income and so is *fully* taxed.

    http://www.financialpost.com/personal-finance/Tapping+mortgage+income+stream/3055942/story.html

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