Receive an income while deferring your taxes

BY FAZAAD BACCHUS

How can you receive an income without paying any taxes? The first thing to understand is that any money you receive which is not earned income does not attract tax in your hands. If someone gifts you a million dollars you are not required to pay tax on receiving it, however, if it grows while in your hands, you will need to pay taxes on the growth. But where do you get income if you haven’t earned it and if you did, how do you defer taxes?

We will venture into this aspect in a few minutes but let me shed light on a few important points.

When you work, you get paid, and in Canada, we are governed by the PAYE system, which means that you Pay As You Earn. To minimize the taxes payable, many people opt to participate in a tax deferral strategy by purchasing RRSP’s. The tax savings are then invested in a tax-sheltered manner and the only time you will pay any taxes would be at the time of withdrawal.

At age 71 you must convert your RRSP to an RRIF and you are required to take a minimum out every year. If you make only the minimum withdrawals, then there is no withholding tax at source, but you will receive a T4 RRIF showing the amounts you were paid. This amount will be added to your total income for the year and taxes will be calculated according to this figure. This rule applies to all registered retirement plans including LIRA and LIF accounts.

Let’s go back to the first paragraph and let’s suppose that you inherited a million dollars possibly from a life insurance death claim, what could you invest this money into? Well, your first option would be to put as much as possible into a TFSA, but you would be limited to the cumulative maximum which is about 60,000. Any growth in the TFSA is tax-free, so as it says … no taxes there.

Now the rest most likely will be invested in a non-registered account. You have a few choices, income or growth (capital gain). Income would be like interest income from a GIC or similar investment, capital gain would be growth on an investment that is being redeemed. Should you decide on interest income, you will receive a T slip showing the income which will be fully taxable at your marginal tax rate. It’s the most ineffective tax strategy you can find yourself investing in.

You have an alternate option. If you invested this money where it grows it is now referred to as capital gain. If you choose to withdraw the gain, which is likened on to the interest in the previous example, it is now taxed at a different rate. Only 50% of your capital gains are taxed at your marginal tax rate, the other 50% is not taxed period, this alone represents major tax savings. But if you really need an income from your non-registered investments and do not wish to pay any taxes, you might want to inquire about a TSWP. This strategy is designed to defer taxes for as long as possible, and the more you defer, the more you earn, it’s a double win.