Written by Andrew Button at The Motley Fool Canada
The 2023 tax deadline is just around the corner. That means it’s time to start thinking about your tax return. Each year, you pay a certain percentage of your income to the Canada Revenue Agency (CRA) as taxes. You also make purchases/donations that lower your income and your taxes. These include refundable tax deductions and non-refundable tax credits. There are also special accounts you can open that exempt your assets from taxation or defer taxation to a date far in the future. In this article, I will explore three easy ways to save on taxes in Canada.
Method #1: Hold bonds in your Tax-Free Savings Account
The most straightforward way to save on taxes is to hold investments in a Tax-Free Savings Account (TFSA). The basic idea here is quite simple: open a self-directed TFSA, open a brokerage account in your TFSA, and then buy investments. If you have already read a little bit about the basics of personal finance in Canada, you probably know this much.
What’s less well known is that not all investments benefit from the TFSA’s tax exemption equally. Stocks already have tax credits applied to them even when held in taxable accounts. When you realize a capital gain, only half of it is taxable (so your capital gains tax is half an equivalent amount of income tax). When you earn dividends, you get a 15% credit on 138% of the amount received — if the dividend is eligible.
With bonds, it’s a different story. Most bonds are simply taxed at your marginal tax rate. Note that your “marginal” tax rate is the tax rate in your highest bracket: your taxes on bond interest will be higher than your average tax rate. Because bonds face such severe taxes, they benefit from the TFSA more than dividend stocks do. So, you should prioritize fixed-income investments like bonds and Guaranteed Investment Certificates (GICs) for your TFSA.
Method #2: Don’t sell good stocks unless it’s absolutely necessary
Another important tax-saving principle is to not sell stocks unless your research shows that the underlying businesses are in decline. If a company is good, it remains good even when its stock price is going down. So, you shouldn’t sell due to factors like emotions or downward-sloping stock charts. The fact that you skip capital gains tax by continuing to hold is just another reason to do so.
We can illustrate this principle by reference to Shopify (TSX:SHOP). Shopify has, by all accounts, given investors a wild ride over the years. It gained a 100% compounded annual rate of return from the seven years between its 2015 initial public offering (IPO) and 2022. Then, in the 2021/2022 period, its stock crashed 82% from top to bottom. If you were trading based on momentum, you’d have wanted to sell at the bottom. But then later, the stock staged a recovery, rallying 180% between the 2022 lows and today.
If you’d bought SHOP at its IPO date or in 2022, you’d have been best off simply holding the stock. Those who bought the 2021 highs still haven’t received a payoff, but they have had many opportunities to lower their cost basis by buying the dip. In a word, holding the line has paid off with Shopify. It has also helped many Canadians avoid taxation.
Method #3: Make RRSP contributions
Last but not least, we have the old favourite: make Registered Retirement Savings Plan (RRSP) contributions. The more of these you make, the lower your tax rate, up to a limit. You do need to be absolutely sure that you will not need the RRSP money until your retirement date, as it is taxed at severe rates when withdrawn early. Apart from liquidity needs, it usually pays to contribute to and invest in an RRSP.
The post CRA Money: 3 Ways to Save on Taxes appeared first on The Motley Fool Canada.
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Fool contributor Andrew Button has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Shopify. The Motley Fool has a disclosure policy.
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