The 2017 Challenge: Reduce Your Income Tax Bill By 15% to 30% (Part II) – MillionaireDowntheRoad.com
Income tax may only be on your mind for a few days weeks in April of each year but, its impact is far-reaching, extending over our entire lifetime.
Why, then, do most of us spend more time (and money) fixing our cars than we do trying to reduce our annual income tax bill? Is it lack of knowledge? Or possibly lack of interest? Or are we just too busy with life to understand that handing over more money to the government each year is simply not in our best interests?
The “why” of all this really doesn’t matter but since I’m in the business of helping people create long term wealth, talking about tax in August when you can do something about it, rather than in April, when it’s all over except for the crying (and possibly the writing of cheques) makes total sense.
Some consider tax savings to be “found” money and want to enhance their lifestyle or take that dream vacation they’ve always talked about. Others prefer to ‘sock away’ tax savings away for a better tomorrow. Whatever you do with it, remember, it’s always better in your hands than theirs!
In the last MDR newsletter, I introduced the 2017 Tax Challenge where I encouraged you to set a target to reduce your tax bill by 5% – 10% each year for the 2015, 2016 and 2017 tax years with the goal of reducing your tax bill by 15%-30% over the 3-year period. It isn’t an easy target, but it’s definitely achievable with a little planning.
I’ve created an 8 Step Tax Reduction Program to guide you through the tax planning process and minimize your generous contributions to government coffers.
The MDR TAX PLANNING PROGRAM
KNOW THE GAME
One key to success in any game is to know the rules. The tax game is no different, and those who know the rules will always have an advantage over those who don’t. Make sure you either know the rules cold or work with an advisor who knows them.
But it’s not enough to just know the rules. You (or your advisor) need to know the nuances of the rules: what you can control, what you can’t, and the risk/reward trade-off of various tax strategies.
There are plenty of resources available for tax planning. Send me an email at: email@example.com and I will be happy to point in the right direction.
ANALYZE YOUR MOST RECENT RETURNS – ARE YOU PAYING TOO MUCH TAX?
You can’t look forward until you look back, so dig out your last 3 years of tax returns for review and analysis. Do you see any anomalies or do your returns all look the same? How much tax are you paying each year? What percentage of your taxable income is going to taxation? What is your marginal tax rate? Is the amount of tax and the percentage you’re paying trending up or down? Like every other game, information is king, so make sure you know your stuff!
CLARIFY YOUR LONG TERM TAX GOALS
Reducing taxes is a key component of wealth creation so you need to be very clear in what you’re trying to achieve with your tax planning. However, no matter what your specific goals are, they’re likely to fall into three general areas:
- Minimizing current income taxes
- Deferring taxes to the future
- Reducing income taxes in retirement
Effective tax planning always focuses on achieving at least one of these goals. Some strategies, like my Dad’s leveraged investment strategy, for example, achieved all three of these goals – something my dad refers to as a “grand slam” in tax planning.
We often joke that dad might be the ultimate “power hitter” when it comes to tax minimization. He understands the rules of the game and does everything he can to minimize his current taxes and defer them far into the future, helping him to compound both his capital and his investment returns for over three decades in retirement.
What are your tax planning goals? Why not become a “power hitter” in your own right by following his time-proven approach to tax planning?
CREATE YOUR PERSONAL TAX PLAN AND MAKE PROJECTIONS
The easiest way to start a tax plan is to simply project next year’s taxes. This becomes your tax blueprint and creates a projection to measure next year’s tax performance against. Want to turn this plan into reality? Simple – just add action!
For example, if you’re planning to contribute $500/month to your RRSP, you have an annual tax deduction of $6,000. Congratulations, you’ve just written yourself a tax refund cheque of $2,000, compliments of the Government of Canada (assuming you’re in a 33% marginal tax bracket).
Investing on a monthly basis locks in the action, so in addition to reducing market timing risk, it also guarantees that your goal will be achieved. Focus on your 2015 projection for now but eventually you’ll want to project two and three years out so you can build on the success of what you accomplish in this first year.
START WITH THE ‘NO-BRAINERS’
Every Canadian should maximize their contributions to Registered Retirement Savings Plans (RRSP’s) and Tax Free Savings Accounts (TFSA’s)… including you.
If you do ONLY these two things you are almost guaranteed an excellent retirement income. Reinvest the tax savings you create from your RRSP contributions into your TFSA and you can increase your retirement savings by more than 30%. Another no-brainer… wow… that was easy!
RESTRUCTURE YOUR PORTFOLIO TO INCREASE TAX EFFICIENCY
You don’t need to be more aggressive in your investment strategy to reduce your taxes but you may need to restructure where you earn your investment income and capital gains. This will minimize the taxes payable on your portfolio. The key to tax minimization is to first decide how much risk you want to take with your investments and then make sure your portfolio asset mix reflects this desired level of risk. Next, allocate this risk as tax-efficiently as you can within your open, RRSP and TFSA accounts by doing some (or all) the following:
- Minimize taxable interest income in open accounts by earning interest from cash and bonds inside your RRSP’s.
- Earn Canadian dividends tax-free in open accounts up to a taxable income of $44,000 and pay about 10% tax on the next $42,000 of Canadian dividend income.
- Make sure you earn US dividend income in your RRSP, as this income will attract the same high rate of taxation as interest income in open accounts.
- Finally, it’s a waste of time to be compounding a miserly 1% in your TFSA. This is the place to be more aggressive with your foreign, non-US equities. Again, offset this risk by reducing risk within your RRSP.
As you can see, where you invest your cash, bond and equity type investments will have a significant impact on your tax bill, so start restructuring today!
ADVANCED TAX PLANNING USING LEVERAGE
My discussion would be incomplete without mentioning the success my dad has had with leveraged investing – both from a long-term return and tax perspective. He’s generated an additional net annual return of 4.4% (taking a 7.4% average annual return to 11.8%). This increase in return led to a ten-fold (10X) increase of both his assets and retirement income over 25 years of retirement. In addition, he was able to pay the absolute minimum amount of income tax possible. This strategy is not for everyone, but since you can offset the addition of leverage risk by increasing the cash and bond components within your RRSP, it can be a highly effective way to increase the long-term return of you retirement portfolio.
ANNUAL TAX PLANNING REVIEW
This is the easy part. In Canada, the CRA sends you an annual Notice of Assessment that officially assesses the income reported on your last year’s tax return. This serves as your report card to analyze how well you are doing against your plan. It also serves as a reminder to update your projection for the next year and make any changes to reach next year’s targeted tax bill.
Finally, I’d like to help you move from theory to implementation using the following checklist. After all, nothing happens until action is taken!
RECOMMENDED ACTION STEPS – CHECKLIST
- Confirm your tax paid from your most recent CRA Notice of Assessment.
- Google “marginal tax rates” for the province you live in to find out your marginal tax rate.
- Establish your 5% – 10% tax reduction target for 2015.
- Evaluate potential tax-reduction strategies (such as those listed here) to decrease your tax bill by your targeted amount.
- Determine your desired action, and take it.
Start planning to reduce your 2016 tax bill by an additional 5% – 10% today.
Questions? Comments? Additional information or advice on the role of tax planning in achieving financial independence?
Contact me today at (604) 638-0342 or firstname.lastname@example.org.