Tax planning is a complex task that requires you to be conversant with every tax you are liable to pay as an individual. It also means you have to be conversant with the relevant tax laws and calculations to enable you to meet the requirements of the law. You must have heard that there are ways to ensure you pay the lowest taxes possible without raising the CRA's attention. Most people end up paying more than they are either because they do not want to employ the services of a tax expert or they lack knowledge on tips for effective tax planning. Tax planning for those without the requisite information is quite frustrating. This article will explain why tax planning is important and some tax planning strategies that you can adopt.
Tax Planning In Simple Terms
Tax planning in simple terms refers to the analysis of your financial plan or current situation in order to ensure that all components work together to allow you to pay the lowest taxes possible.
Tax Planning Explained
Tax is an inevitable mandatory financial charge that is imposed by the government on anyone qualified to pay them under relevant laws. Failure or resistance to paying taxes is regarded as a crime and punishable under the law. One way to ensure that you maximize all available legal methods to reduce the amount of tax you pay is through tax planning.
Tax planning is the process of arranging your financial and business affairs in such a manner that will attract the lowest tax rates under the relevant tax laws. In other words, it is the process of limiting the amount of taxes you pay without breaking any law. An efficient tax plan will minimize how much taxes you pay and is an essential part of your financial plan. Tax planning involves the optimization of marginal tax rates using different calculations and means such as Trust arrangements, charitable entities, corporations, tax exemptions, deductible expenses, profit-shifting arrangements, and some other means. One thing to note about tax planning is that while you pay reduced tax rates, it must be done within the purview of the law. Tax planning is entirely different from tax evasion which is a crime.
When developing a tax plan, some of the things to consider include the timing of your income, the size of your income, the timing of your purchases, and the plans you have for your other expenditures. Also, the types of investment portfolios and retirement plans you choose must complement your tax filing status and deductions to create an efficient tax plan.
Types of tax planning
Some of the types of individual tax planning include:
Tax Planning using Government Programs
This tax plan is using tax benefits offered by the government of Canada. Some of which may include registered plans such as Tax Free Savings Account (TFSA), Registered Education Savings Plan (RESP) and Registered Disability Savings Plan (RDSP). You will also get tax benefits on your charitable donations and withdrawing from your RRSPs through Home Buyers Plan.
Retirement Tax Planning
This is a tax plan that allows you to enjoy your post-retirement days by reducing your tax liability and maximizing your income at that stage of your life. You can enjoy deferred taxes on your Registered Retirement Savings Plan (RRSP), Canada Pension Plan (CPP), and for some, Individual Pension Plan (IPP).
Estate Tax Plan
Believe it or not, when you pass away, your estate is still subject to taxes. Yes, even the dead pay tax. You should put a tax plan in place that will preserve the value of your estate. You can enjoy the benefits of plans like Tax Free Savings Account (TFSA) or taking out life insurance to pay for those taxes.
Importance Of Tax Planning
Paying your taxes is important for so many reasons. For one, it ensures that you stay on the right side of the CRA. However, there are ways to ensure you pay less in taxes without contravening the law. With a well-prepared tax plan, you can enjoy paying taxes while you also build your financial plan and enjoy maximum benefits from your financial plan. Here are some of the importance of tax planning:
Solves Tax issues
Having a tax plan will help you pay up any back taxes you owe and also solve any other tax issues you may have.
With a tax plan, you can save some extra cash and divert it into your savings or investments. It is an opportunity to grow your wealth with a smart tax plan.
Building An Education Fund For Your Child
The extra cash you get from smart tax planning can be diverted to fund your child’s education. You do not need to start sweating for cash to build an education fund when you can easily get it from paying less in taxes through your tax plan. You can take advantage of the Registered Education Savings Plan (RESP) which allows you to save for your child’s post-secondary school education and also earn tax-deferred income. On top of that, you also attract government grants that can help grow this savings faster.
Flexible Tax Payment Schedule
A tax plan will inform you on when to pay up your taxes. This eliminates unnecessary stress and uncertainties when it comes to paying your taxes. It allows you to take advantage of the tax installment opportunity where you can spread the payment of the tax owed over the course of the year.
Building a tax plan will mean you have to be up to date on the relevant tax laws and tax liabilities. In other words, tax planning is a learning opportunity about relevant information on taxes and relevant laws. You also get to learn about some tax tips and legal tricks you can use to pay less in taxes.
What Are The 3 Basic Tax Planning Strategies?
Tax planning strategies will ensure the efficiency of your tax plan to reduce your tax liability. Tax planning strategies revolve around 3 components which include reduction in income, increasing deductions, and utilizing available lower tax rates. Three basic tax planning strategies you can adopt include:
Income splitting and Shifting
Tax splitting is when you shift income across your family members or legal entities. When you split your income across your family unit, you enjoy reduced tax rates. You can also shift different types of income such as bonuses, dividends, and your year-end payments to a period when you will enjoy lower tax rates. You may also use a Spousal RRSP to split your retirement income in the future.
Deferring your tax payment will allow you to pay your tax at another time. You can do this by using specific investment portfolios that allow deferred tax payments. A good example is a pension plan contribution and RRSPs that allows you to defer your tax payment till a later date in the future.
You can choose selective investments that will afford you exemptions from federal or provincial tax. One registered investment program is a Tax Free Savings Account (TFSA) with tax free earnings that may benefit your tax plan. Another investment with tax benefits are flow through shares.
Tax Planning Tips
Some basic tips on tax planning will give you the benefit of enjoying tax advantages without the help of a tax expert. Here are some of the tips you can consider for your tax plan:
Choosing the right investment will enable you to enjoy some tax benefits. Some investments such as stock are accorded tax breaks on dividends and capital gains. You should be careful of putting your money in fixed-income investments such as GICs and Bonds because they do not have tax benefits. They are fully taxable and will cost you money.
More Philanthropic Activities
Donating to charity does not only mean you get to help those in need, but you can also enjoy some tax benefits that come along with it. Charitable donations have their fair share of tax credits or deductions which will be a good addition to your tax plans. The essence of the tax benefits on donations is to encourage people to give to the needy.
Assess Your Deduction Strategy
If you have several expenses to meet up with, it is best you itemize the deductions available to you. There are deductions you can enjoy as the head of a household and there are the ones you can enjoy if you file jointly with your spouse. Itemizing them gives you clarity on the benefits that are available to you and it helps you divert the deductions for other useful purposes. For example, your Registered Retirement Savings Plan (RRSP) allows you to enjoy tax deduction and tax-free growth on your earnings until retirement.
Start A Side Business
Asides from being your boss and building something for yourself, starting a business also has its tax benefits. One advantage is that you can deduct many of your expenses from the income from your business which will reduce your tax obligations. Some of the tax deductions you can enjoy as a business owner include health insurance premiums, home office tax deductions.
Aim For Capital Gains
Investment is an important aspect of a financial plan because it is what determines how well and fast your wealth will grow for a financially secured future. Investment portfolios such as mutual funds, stocks, bonds, and real estate have their tax advantages if you shoot for capital gains. Capital gains have much more favourable tax treatments compared do dividends, rental and interest income.
Borrow To Invest and Save To Buy
Almost everyone has one debt or the other hanging over their heads. If you are going to have one, you might as well make most of it. Taking out a loan for investment purposes has its tax advantage. The interest on loans taken out for the purpose of investing can be tax-deductible as against taking a loan to make a purchase. This is a wake-up call to change your orientation, borrow to invest and save to buy.
Open A Tax-Free Savings Account (TFSA)
The investment income earned on the funds you invest in a TFSA is not subject to tax when earned or withdrawn. It is a sure way of maximizing the tax benefits available to you. Another benefit of a TFSA is that your contribution room is replenished the year following your withdrawal.
Tax Planning For Individuals Conclusion
Tax planning is very important and has its advantages. However, you should be careful and ensure your tax plans will not put you on the wrong side of the law. Know the limits the law provides to clearly distinguish your tax reduction from tax evasion or tax avoidance. Keep abreast of changing tax laws to maximize any benefit available to you, depending on your investment plans and your finances generally. If developing a tax plan is becoming complex for you, it is advisable to seek the help of a professional tax accountant or certified financial planner to help you out your tax plan within the ambit of the law.