Do you need to make income tax instalment payments?

Twice a year, Canada Revenue Agency sends out instalment reminder letters to those taxpayers who are required to make payments. The February letter outlines the required payments on, or before, March 15 and June 15. The August letter outlines the required payments on, or before, Sept. 15 and Dec. 15.

 

The February 2019 notice will be based primarily on your 2017 tax return. If you owed more than $3,000 in taxes in 2017, then you will likely be asked by CRA to make instalments on March 15 and June 15t through the February 2019 notice. CRA would not know what your income was for 2018 by the time the February notice are sent. Nor will it know what your income will be for the current year.

The August 2019 notice will enable CRA to adjust the numbers based on your actual 2018 net tax owing. If your net tax owing was less than $3,000 in 2018, you will likely not be asked to make instalment payments on Sept. 15 and Dec. 15.

It is important to note that you have to pay your income tax by instalments for 2019 if both of the following apply:

• Your net tax owing for 2019 will be above $3,000 in British Columbia

• Your net tax owing in either 2018 or 2017 was above $3,000 in British Columbia

The instalment payments are to cover tax that you would otherwise have to pay in a lump sum on April 30 of the following year. Instalments are designed so that taxes are paid throughout the calendar year while you are earning the taxable income.

Infrequent income spike

We often see individuals who have sold a rental property, businesses or investments, which generates a significant capital gain. This is a one-time spike in income, which is not going to necessarily repeat. One of the flaws in the instalment notice is that it is simply an automated process based on the $3,000 thresholds notice above. The year after you have a spike in income, many people are asked to make instalment payments.

You do not have to pay your income tax by instalments for 2019 if you know your net tax owing for 2019 will be $3,000 or less in British Columbia, even if you received an instalment reminder in 2019. It is always best to check with your accountant before skipping instalment payments.

Common areas triggering instalment notices

If you are an employee, and have no other sources of income, you likely do not have to worry about making instalment payments. Your employers has an obligation to withhold appropriate income tax from your earned income. Individuals who work more than one job may also have an insufficient amount of tax withheld, as each employer has based the withholding tax on payroll tables and income from the one job. If you do have two jobs and when both incomes are combined, you are in a higher tax bracket than the payroll table. This will normally result in taxes being owed at the end of the year. You can always request that your employer withholds a higher level of tax on a voluntary basis.

There are situations where taxpayers have income from activities other than employment. In many of these cases, tax is not withheld at source, meaning that you may have to pay tax at the end of the year. This often impacts individuals who have multiple forms of income.

Examples of situations that can result in instalment payments include self-employment income, RRIF payments, Old Age Security payments, Canada Pension Plan benefits, rental income, certain pension income, capital gains and other investment income.

Speaking with a wealth adviser and accountant about instalment payments can often result in some helpful tips on ways to reduce your net tax owing, or even eliminate the need to make the CRA scheduled instalment payments. The easiest way to reduce your net tax owing is by voluntarily withholding tax on certain forms of income on an automated basis. You can withhold tax on your RRIF income by talking to your wealth adviser. Another common strategy is to complete the “Request for Voluntary Federal Income Tax Deduction” form to have tax withheld on Canada Pension Plan and Old Age Security.

Interest and penalties

For some people, making the instalment payments is not a big deal. They simply make the four remittances a year on time. In order to make these instalment payments on time, you have to be organized, have the funds previously set aside and remit them to CRA on or before the required dates.

If taxpayers do not make the required instalments, they may have to pay interest and penalty charges. CRA charges instalment interest on all late or insufficient instalment payments. Instalment interest is charged at the posted prescribed rate (changes every three months) and compounds daily. CRA may also charge penalties if the taxpayer makes payments that are late or less than the requested amounts. Penalties normally apply when your interest charges are more than $1,000.

The worst part about these types of interest and penalty charges are that taxpayers cannot deduct these on their tax return. This is an absolute cost that is permanently lost.

Notice of assessments

One of the services we provide to clients is a review of their tax returns. Fifteen years ago, we used to ask clients to bring in tax returns and notices of assessment, but now we have been able to proactively get this information online, directly from CRA. One of the first documents that we read every year is a client’s notice of assessment. With respect to instalments, we look for three things:

1. Do they have a requirement to make instalment payments?

2. Were any interest or penalties assessed in previous years for not paying required instalments?

3. How can we help the client automate the process?

In some cases, withholding tax on RRIF, CPP and OAS is not enough. Some clients do not wish to voluntarily send CRA any money ahead of time. One of the services we provide for clients with a non-registered account is the ability for us to pay their required instalment amounts directly from their investment account. We have access to the numbers on the CRA website and if a client has provided consent, we can take care of those payments on their behalf. This is particularly valuable for our clients who are busy, travelling or aging.

Kevin Greenard CPA CA FMA CFP CIM is a portfolio manager and director of wealth management with the Greenard Group at Scotia Wealth Management in Victoria. His column appears every week in the Times Colonsit. Call 250-389-2138. greenardgroup.com

 

Many couples should consider spousal RRSPs

For couples that make approximately the same annual income, a spousal RRSP may not be necessary. The greater the disparity between incomes with couples, the more important it is to consider spousal RRSPs. This is especially true if one person is in an upper tax bracket and your spouse is in a lower tax bracket. If investment dollars are limited, then the recommendation would normally be for the upper tax bracket individual to make an RRSP contribution.

With fewer and fewer income splitting opportunities between spouses, it is important to understand the strategies that remain. Spousal RRSPs are an effective way to split income between spouses during your lifetime. However, it is important that you know the rules.

What is a spousal RRSP?

A spousal RRSP is an account to which you contribute, however your spouse is the annuitant of the account. This means that you receive the tax deduction for the contribution to the account, but your spouse will receive the proceeds from any withdrawals from the spousal RRSP. Once the contribution is made, your spouse becomes the owner of the funds within the account.

The advantages of a spousal RRSP

The biggest advantage of a spousal RRSP is the opportunity to split retirement income between spouses.

Effective retirement planning would result with both spouses having equal income producing assets at retirement. This would allow the family to take advantage of splitting income instead of having it all taxed in one individual’s hands, which is normally at a higher marginal tax rate.

Most people will not have equal assets at retirement, so the spousal RRSP is a method to help ensure that you work towards equal assets at retirement.

Usually, the higher income spouse (and therefore the spouse that is likely to have higher assets at retirement) will contribute to a spousal RRSP for the lower income spouse to allow them to accumulate assets for retirement. When you finally retire, the withdrawals from the spousal account will be taxed in the hands of your spouse, usually at an overall lower tax rate than would be the case if the withdrawal was taxed in your hands.

The advantage to this income splitting strategy is based on the fact that the contributor receives a tax deduction at a higher tax rate than the income will ultimately be taxed at.

Know the rules and be careful of the attribution rules

There are rules in the Income Tax Act called attribution rules that are designed to prevent abuse of spousal RRSPs. The rules state that:

• Withdrawals from a spousal account will be taxed in the hands of the contributor if a contribution has been made to any spousal account in the year of the withdrawal or the previous two years. What this means is that if you made a contribution to any spousal account, you must wait three years before your spouse can withdraw it without it being taxed back to you.

The attribution rules do not apply in the following circumstances:

• If funds are transferred directly for your spouse or common-law partner to a RRIF and only the minimum payments are withdrawn, there is no attribution. However, there is attribution on funds withdrawn in excess of the minimum payment as long as the three years is still in effect. After the three years has passed, there is no further attribution.

• If funds are used to purchase a life annuity or a term certain annuity to age 90, there is no attribution

• If the spouses are living apart due to a breakdown of relationship at the time of payment

• If either spouse becomes a non-resident of Canada at the time of payment

• If the contributing spouse dies in the year of payment

• If the deceased annuitant is considered to have received the amount because of death

One of the most popular questions relating to spousal RRSPs is: “Can my spouse co-mingle their own RRSP with that of their spousal RRSP that I contribute to?”

The answer is yes, however, once you co-mingle the accounts, they are considered a spousal account and therefore subject to the attribution rules discussed above.

We do not recommend co-mingling RRSP accounts. There are reasons to keep the accounts separate, depending upon your circumstances. Having two plans provides you with extra flexibility with respect to withdrawals. For example, if your spouse was not working and wanted to withdraw funds out of their RRSP, they could withdraw them out of their own RRSP and have the income taxed in their hands. If however, the funds had been co-mingled and a spousal contribution had been made within the last three years that income withdrawal would be taxed in the hands of the contributor.

If you are at the age where you have only RRIF accounts and are pulling out the minimum, then co-mingling the accounts at this stage is normally okay.

Other factors and looking at the long term

In some situations, one spouse may be temporarily out of the work force and will have significant income in the future. Individuals that own corporations or other assets should seek professional advice to see how a Spousal RRSP could integrate into a longer-term plan. Stability of marriage, future inheritances, projected retirement dates, and changes in Canadian tax laws are additional factors to consider.

 

Investment options within your RRSP

The key word in Registered Retirement Savings Plan is savings.

The government allows Canadians to defer up to 18 per cent of the previous years earned income, up to a maximum of $26,230 for the 2018 tax year.

In order to reach the maximum, earned income would have to equal $145,722 or higher. If you are a member of a pension plan, then the maximum is reduced by a pension adjustment.

After filing your annual tax return, you will receive a Notice of Assessment which has your current year RRSP Deduction Limit Statement.

Once your Deduction Limit is known, you may consider contributing early to an RRSP provided cash flow permits. One way to do this is to immediately use any tax refund, if any, to fund the current year RRSP contribution. If you are maximizing every year, then a single lump sum contribution equal to the amount on your RRSP Deduction Limit Statement may avoid the risk of over-contributing.

If cash flow is limited then setting up a Pre-Authorized Contribution (PAC) on a monthly basis may help you maximize contributions. It is important to adjust the PAC amount annually to adjust to your annual RRSP Deduction Limit. Whether you contribute monthly or by lump sum, it is important that you know your limit and do not over-contribute.

Every year you have to decide how to invest the new contribution. In addition to deciding how to invest the current year contribution, you have to continually manage your existing RRSP holdings to get the best long term results.

We have had discussions with clients new to investing that had mistaken an RRSP as a type of investment. RRSP is a type of account but not a type of investment. The Income Tax Act (ITA) outlines that the RRSP is limited to holding qualified investments, such as cash and deposits, listed securities (on designated stock exchanges), investment funds (i.e. mutual funds), and debt obligations (i.e. GICs, Term Deposits, Canada Savings Bonds). There are several other less common types of investments for RRSP accounts but for purposes of this column I will stick with the most common.

Many people rush into a financial institution to deposit funds primarily to get the RRSP Contribution receipt for tax purposes. Although cash is a qualified investment with RRSP, sitting permanently in cash is not a good long term option as returns would be limited.

Before an RRSP contribution is made you should understand the differences between financial professionals and financial institutions. There are significant differences with financial professionals in the scope of both experience and licencing. Some have worked through various market corrections and others are just starting a new career. Some financial professionals are licensed to sell only insurance products, other are licensed through the Mutual Fund Dealers Association (MFDA) and sell mutual funds. Wealth advisers may be licenced with the Investment Industry Regulatory Organization of Canada (IIROC) and have the ability to sell listed securities and mutual funds. You should ensure that the Wealth Advisor you approach has the licensing appropriate to your needs.

With respect to the wide range of financial institutions, you can choose from virtual/online options, insurance companies, traditional banks, credit unions and mortgage investment corporations. You should first determine what type of investment you would like and also what type of services. Even within traditional banks, you have several options including: self-directed, bank branch, and full service. If someone wants to do their own investing and is comfortable with technology then they can consider the online self-directed platforms. These are also referred to as discount brokerage as they have lower fees as you’re primarily doing the work yourself. Options at the bank branch level are typically term deposits/GIC and mutual funds.

Guaranteed Investment Certificates

Some investors purchase GICs, term deposits, and different types of bonds within an RRSP to manage their investment risk level. These types of investments typically pay interest income that is predicable, and volatility is lower. The primary downside to these investments is the relatively low interest rates and return potential. Short-term debt obligations have low real returns after inflation and taxes are factored in. Long-term debt obligations can be surprisingly volatile especially with changes to interest rates. If capital preservation is the primarily objective and time horizon is short, certain types of debt obligations may be suitable.

Mutual Funds

Mutual funds have been around for more than 90 years and have been a very popular type of investment. The concept of a mutual fund is easy to understand in the sense that it is a group of investors who pool their money together and have it managed by a Portfolio Manager. The first stage is picking a fund that matches your investment objectives and risk tolerance. Once the fund is picked, the portfolio manager makes all the decisions and investor does not need to be involved. Another benefit is that investors can choose to contribute a lump sum to the fund or set up automated pre-authorized contributions every month which makes forced savings easy. For inexperienced investors, or those with smaller amounts to invest, a mutual fund allows you access to a professional money manager. You do need some guidance to ensure you pick a mutual fund(s) with the appropriate asset mix and level of diversification. All of the banks offer a selection of mutual funds.

Listed Securities and Wealth Advisers

Investors that have accumulated significant savings have another option available to them. The full-service wealth division of Canada’s largest banks provide a wide range of investment options, typically for clients with investable assets over certain thresholds (i.e. $250,000, $500,000, $1,000,000). As noted above, wealth advisors are registered with IIROC and are able to purchase a wide selection of investments within an RRSP, including the investments noted above, as well as listed securities. One type of popular listed security is common shares that trade on exchanges such as Toronto Stock Exchange, New York Stock Exchange and Nasdaq.

The greater the size of an investment portfolio, the easier it is to obtain diversification with individual holdings. The benefit of transitioning to individual securities is lowering your cost of investing and having more control over the risk level of the account and each security added. It is easier to diversify your portfolio by sector and geographic exposure. Individual blue chip equities typically generate greater income and provide better transparency.

Avoiding significant mistakes is a key component to the success of an RRSP. Common mistakes we see are being too conservative or too aggressive. Keeping the funds in cash or being too conservative will not result in wealth accumulation after inflation and income tax are factored in. Investing in speculative holdings, unnecessary concentration, and making emotional decisions during periods of volatility are also common mistakes.

Kevin Greenard CPA CA FMA CFP CIM is a portfolio manager and director of wealth management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week in the Times Colonist. Call 250.389.2138.

The mathematical approach to RRSP contributions

The Income Tax Act allows you to contribute up to 60 days after the end of the year to your RRSP.

For the 2018 tax year, the last day to contribute is Friday, March 1. This 60-day buffer gives you ample time to estimate your taxable income and determine if it makes sense to make a contribution.

Assuming it makes sense, the next step would be to look up your 2018 RRSP Deduction Limit. This can be obtained either by looking at your previous year’s Income Tax Notice of Assessment. Within this notice you should see a table that is titled “2018 RRSP Deduction Limit Statement.” This table provides your RRSP deduction limit for 2018 and will note the dollar amount of any unused RRSP contributions. If you have unused RRSP contributions, this amount must be subtracted from the RRSP deduction limit to obtain a net amount. Unused RRSP contributions are amounts that you contributed in past years but have not yet claimed.

To illustrate, your statement could show $26,480 on the RRSP deduction limit line. On another line it may show $12,100 of unused RRSP contributions. In this situation, the maximum you would be able to contribute, and be able to claim as a deduction, is the net amount of $14,380. CRA does permit individuals to contribute $2,000 over and above this net amount without being subject to the one per cent per month over contribution penalty.

Now you have estimated your taxable income and you know the maximum net amount to contribute.

In next week’s column, we have listed 50 questions people should ask themselves before jumping directly in. It is still early in February and you have lots of time to still make an informed decision.

Perhaps one of the more simplistic approaches is to estimate the tax savings if an RRSP contribution is made. Reviewing both the federal and provincial marginal tax brackets is the starting point.

Federal tax rates for 2018

• 15 per cent on the first $46,605 of taxable income, +

• 20.5 per cent on the next $46,603 of taxable income (on the portion of taxable income over 46,605 up to $93,208), +

• 26 per cent on the next $51,281 of taxable income (on the portion of taxable income over $93,208 up to $144,489), +

• 29 per cent on the next $61,353 of taxable income (on the portion of taxable income over $144,489 up to $205,842), +

• 33 per cent of taxable income over $205,842

B.C. tax rates for 2018

• 5.06 per cent on the first $39,676 of taxable income, +

• 7.7 per cent on the next $39,677, +

• 10.5 per cent on the next $11,754, +

• 12.29 per cent on the next $19,523, +

• 14.7 per cent on the next $39,370, +

• 16.8 per cent on the amount over $150,000

This math-oriented approach can be simplified through many online RRSP calculators. The estimates below are from https://www.ey.com/ca/en/services/tax/tax-calculators-2018-personal-tax

Taxable Income

Taxable income before RRSP contribution Taxes payable before RRSP RRSP contribution Taxes payable after RRSP Taxes savings difference ($) Taxes payable difference (%)
$10,000 $0 $10,000 $0 $0 00.00%
$20,000 $1,256 $10,000 $0 $1,256 12.56%
$40,000 $5,734 $10,000 $3,618 $2,116 21.16%
$80,000 $16,669 $10,000 $13,831 $2,838 28.38%
$120,000 $31,285 $10,000 $27,230 $4,055 40.55%
$160,000 $48,241 $10,000 $43,661 $4,580 45.80%
$200,000 $66,561 $10,000 $61,981 $4,580 45.80%
$240,000 $86,247 $10,000 $81,267 $4,980 49.80%

No Taxable Income

For individuals with no taxable income, we do not recommend contributing to an RRSP as there are no tax savings. If a child or individual has earned income and they are under the basic exemption it may still be beneficial to file a tax return. Filing a return will report the earned income, 18 per cent of which will be used to build up RRSP contribution room for the future. One day when the individual has higher taxable income they will also have RRSP room they can take advantage of.

Lowest Marginal Rates

Individuals who are in the lower marginal tax bracket but are expecting a significant increase in salary next year may be better off delaying their RRSP contribution. If an RRSP contribution is made then the individual may be better off not claiming the deduction and carrying forward the unused portion to the subsequent years when it is more advantageous. If your income is below the top of the first provincial tax bracket (2018 this is $39,676) you should look at all the non-mathematical components of the RRSP decision.

Highest Marginal Rates

Those in the highest marginal tax brackets may benefit the most from RRSP contributions. Canadian taxpayers have few ways to lower their taxable income — an RRSP contribution is one. As illustrated above, individuals in the 49.8 per cent marginal tax bracket may reduce taxes payable by about 50 per cent of the amount they contribute. In addition to the tax deduction any potential growth within the RRSP compounds on a tax-deferred basis until the funds are taken out as a withdrawal (hopefully in a lower tax bracket in retirement). If you are in the highest marginal tax bracket, with taxable income over $205,842, we normally recommend contributing to an RRSP from a mathematical perspective.

Many people are in the grey zone, with income above $39,676 and below $205,842. The mathematical approach is useful, but often is too simplistic. Next week we will outline 50 questions to help those in the grey zone determine if making an RRSP contribution is right for them.

Kevin Greenard CPA CA FMA CFP CIM is a portfolio manager and director of wealth management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week in the Times Colonist. Call 250.389.2138. greenardgroup.com

Part II – RRSP Turns 60: Still a Good Bet for Retirement

Registered Retirement Savings Plans (RRSPs) were first introduced 60 years ago, created by the federal government to help people who didn’t have a work pension to save for retirement by socking away pre-tax money.

In 1957, the threshold for the RRSP was the lesser of 10 per cent of income or $2,500.  Over the years the threshold methodology has changed.  Over the years, the threshold methodology has changed. Since 1991, the income threshold of 18 per cent of income has been used.

Starting in 1996, and continuing to today, the new contribution ceilings were indexed to the rise in average wages.

For 2017, the annual maximum, or contribution ceiling, is $26,010, which is reached when earned income is at $144,500 for the prior year.  After you file your 2016 tax return, the government communicates to taxpayers their 2017 RRSP contribution limit on the Notice of Assessment.

The calculation for the RRSP contributions limit is adjusted for individuals who have a work pension.   This reduction is referred to as a pension adjustment and also shows up on your Notice of Assessment.

A pension adjustment is done for both Defined Benefit Plans, where employers bear the risk of market-value changes, and Defined Contribution Plans, where employees bear the risk.

Pension plans have been deteriorating over the last decade.  Individuals who either do not have a pension through work, or do not have a good quality pension, should consider having an RRSP.

Outside of the two types of pensions, some employers will offer a program to help build up your RRSP, or other accounts.  In some cases, these are matching type programs, where you can put in a certain percentage of your salary, and your employer will match it, up to a defined threshold.  These are often referred to as a group RRSP and it is worth participating in.

If you have an RRSP program at work, then having that one is a must.  As you are typically restricted by the types of investments you can invest in with a group plan, we encourage people to also have one external RRSP account.

The external RRSP account would hold all the contributions done outside of your group plan.  In some cases, individuals can transfer funds from a group RRSP to an external RRSP.  In other cases, the funds must stay in a group RRSP until you cease employment with the sponsoring company.

You should receive a statement for any company sponsored pension.  Reviewing this statement is especially important if your plan is a Defined Contribution Plan where you had to make investment choices.

You have made decisions to determine the percentage to invest in fixed income versus equity and whether to have Canadian equities versus foreign equities.

If you have a group RRSP plan, you likely can view information electronically and also receive statements more frequently.

All of this information should be provided to your financial advisor, prior to making any financial decisions regarding your external RRSP.

As the quality of pension plans has deteriorated, the methodology of how to invest funds within an RRSP has changed for some investors.  The three broad categories are cash equivalents, fixed income, and equities.

In 1957, a 90 day treasury bill (cash equivalents) could be purchased with an interest rate of 3.78 per cent, climbing to 17.78 per cent in 1981.

Investing RRSPs in conservative investments, such as cash equivalents, provided decent enough returns during this period.  The latest T-Bill auction of 2016 had the 90 day treasury bills paying a yield of 0.50 per cent.   Most would agree that putting the investments within your RRSP into cash equivalents would not provide the returns to keep pace with inflation, especially after tax is factored in.

Bonds are a type of investment that is classified within fixed income.   The reason most investors purchase bonds is for capital preservation and income.  In order to achieve the goal of capital preservation, it is advisable to invest in investment-grade bonds.  Yields on these bonds are at historic lows.  The yield curve is also very flat, so purchasing a longer term investment grade bond does not increase the yield significantly enough to warrant the potential risk if interest rates rise.   The primary reason to hold bonds in an RRSP portfolio today is capital preservation.

Equity investments provide both growth and income.  In fact, the right types of common shares can pay dividend income that exceeds the interest income on most investment-grade bonds.  Portfolio values will fluctuate greater as the equity portion increases.

An advisor can put together a portfolio of lower risk stocks, often referred to as “low beta” that can reduce this volatility.  We feel those who tolerate increased volatility will be rewarded in the long run by holding the right equity investments.

Kevin Greenard CPA CA FMA CFP CIM is a Portfolio Manager and Director, Wealth Management with The Greenard Group at Scotia Wealth Management in Victoria.  His column appears every week in the TC.  Call 250.389.2138. greenardgroup.com 

This is for information purposes only. It is recommended that individuals consult with their financial advisor before acting on any information contained in this article.  The opinions stated are those of the author and not necessarily those of Scotia Capital Inc. or The Bank of Nova Scotia. ScotiaMcLeod is a division of Scotia Capital Inc., Member Canadian Investor Protection Fund.