Your Simple Financial Plan, Part 8- Taming The Taxman
Taxes are nobody’s favourite subject. All the more reason to talk about them.
Talking about taxes is like visiting the dentist. We know we need to do it but can’t wait to get it over with. All kidding aside, it’s worth it to make sure you and your spouse are doing what you can to economize on one of the largest expenses in your household budget.
Welcome to my final chapter of your DIY Financial Plan. I would never give advice that I don’t follow myself and taxes are something I pay the utmost attention to. When it comes to cherry pie, I want the biggest slice I can get! When it comes to taxes, I want my slice to be as teeny, tiny as possible.
As 2013 draws to a close, there is little you can do about this year’s tax bill. But once you toast in the new year, it’s the perfect time to think about ways to keep more money in your pocket.
Here are 5 questions to ask yourself…
1) Am I saving money in a tax effective way? Using tax sheltered plans to save money for the future is the right thing to do. This is especially true if you’re in a high tax bracket and you get an immediate tax deduction. Just remember to think long term and optimize your lifetime tax bill. You don’t want to pay a higher rate of tax in retirement than you did when you were working. For example, if you expect to pay more tax in retirement than you do now, it might make sense to maximize your TFSA (rather than your RRSP).
2) Am I investing money in a tax effective way? Dividends, capital gains and interest income are taxed at different rates. Make sure you pay attention to where you hold these investments. For example, if you are in a high tax bracket, it’s smarter to earn interest income in registered accounts (TFSA’s, RRSP’s, even RESP’s) and dividends or capital gains in non-registered accounts.
3) Am I aware of and taking advantage of income tax deductions that apply to me? If you are self employed or own your own business, you will have more ways to reduce income taxes than an employee. However, if you have children or a stay-at-home spouse, don’t forget about the many deductions and tax credits available to you. Have a look at Ernst & Young’s Personal Tax Guide to get more familiar with Canadian taxes, deductions and planning opportunities.
4) Do I know my marginal and average tax rates (and those of my spouse)? It pays to know these rates; i.e. how much of each additional dollar of income earned that you can keep yourself. It’s much more important to be aware of your financial resources AFTER TAX than before tax. Play with Ernst & Young’s tax calculator to see how much you have left over after tax.
5) Are my spouse and I taking full advantage of opportunities to reduce our combined taxes? If one spouse is in a high tax bracket and the other in a low tax bracket, consider ways to split income and pay less tax overall i.e. spousal loans etc.
Many people hire a tax professional to prepare their annual returns. I would argue that it is equally, if not, more important to pay an expert for tax planning advice. The younger or wealthier you are, the more it can pay off over time. Paying attention to your family’s tax situation both pre and post retirement can make a big difference to your disposable income. You’ve worked hard for your money so you should get to keep as much as you can!
Here’s to the New Year and a fatter bank account in 2014!