There is an old axiom, “The best time to plant a tree was 20 years ago. The next best time is today.” Don’t let tax planning failures in years past hinder your ability to make plans for this year. So, how can you start using simple tax planning to your advantage, avoiding tax debt?
Using Simple Tax Planning to Your Advantage with Forced Savings
You can use taxes as a forced savings program. If you are on a regular pay plan and withholding taxes are deducted on each paycheque, then you can force a savings program. Ask for an additional dollar amount (perhaps $25 per pay), to be deducted. This overpays your taxes due during the year by $650, which would be added to your tax refund.
The upside of asking for more to be deducted is it forces you to live within a lower net-income budget and provides a bonus at tax time. This can be an attractive alternative if you have a problem with money and self-control. You can use this bonus to pay down debt when you receive your tax return. The downside is that you are lending the government funds at 0% interest. There are better options.
Creating Savings and Refunds
Instead of deducting income from your paycheque for the CRA to hold, pay yourself by putting money into a Registered Retirement Savings Plan (RRSP). If it is an option, ask your employer to deduct an amount from your paycheque to be directly deposited into an RRSP. This functions the same as the forced savings above, but with the added benefit of generating an annual refund and increasing your savings at the same time.
What is an RRSP?
An RRSP is a Federal Government program to help you save money for retirement (especially with the decline of corporate pension plans in the private sector over the last 40 years). Almost any investment can qualify for a plan, such as stocks, bonds, mutual funds, Guaranteed Income Certificates (GICs), and savings accounts. Consult a financial advisor to select the proper investment for your age and risk profile.
What if I Am Self-Employed?
If you’re self-employed, you have a unique tax planning problem. Your income streams may be erratic. This can make it tough to plan, but not impossible. Rather than using a set dollar amount, a self-employed person can save a set percentage — even a small one — in an RRSP to provide retirement income and a tax reduction for the year.
Income taxes for entrepreneurs are calculated based on net income in a year — most importantly, on a cash basis. Keeping an accurate record of your business finances will give you a reliable estimate of your income. As year end approaches, choose whether to spend on your business in the current year or wait until the following year.
Other Considerations for Reducing Taxes
Maintaining good financial records, including items that can be used to reduce taxes (such as donations, political contributions, medical expenses, or relocation expenses) can help you avoid a surprise at tax time and even provide a big tax return. Then you can put money into additional investments to pay off debt, using simple tax planning to your advantage.