A Registered Retirement Savings Plan (RRSP) is one of the most tax-efficient investment products available. Not only can you claim a tax deduction for amounts contributed, but any gains arising on investments held within an RRSP are not taxed until they are withdrawn (which can be staggered to take advantage of available tax brackets each year).
Generally, your available contribution room for 2023 is 18% of your “earned income” (a defined term) for 2022, to a maximum of $30,780 (adjusted for inflation each year), plus all unused contribution room from earlier years.
If you have a registered pension plan or a deferred profit sharing plan, be careful as these usually reduce your RRSP contribution room. You can check your available contribution room on CRA’s My Account for Individuals, or on your 2022 Notice of Assessment.
One advantage of RRSP contributions, in terms of year-end planning, is that contributions made by February 29, 2024 can be used to reduce your tax for 2023. Therefore, it is possible to calculate your tax liability early in 2024 and make RRSP contributions accordingly. Note that the deadline is usually March 1, but since 2024 is a leap year, it is February 29!
If part of your income falls into a high tax bracket this year, it may be possible to make strategic RRSP contributions to prevent tax from applying at high-taxed rate, while saving some contribution room for future year high tax bracket income.
For example, if an Ontario resident’s taxable income was $110,000 for 2023, an RRSP contribution of $1,000 would save them $434 in tax, whereas if their taxable income was $100,000, the same contribution would only save them $339 in tax, as their final $1,000 of income is taxed at a lower rate.
One exception to the February 29, 2024 contribution deadline is if you turn 71 in 2023. In this case, you can only contribute up to December 31, and you must close your RRSP by the end of the year (usually by using the balance to purchase an annuity or transferring it into a Registered Retirement Income Fund, which is like an RRSP but takes no new contributions and requires a certain amount to be paid out and taxed every year.)
One other major advantage of contributing to an RRSP is that spouses can use this to split their income. For example, a high-earning individual can establish a second RRSP in their spouse’s name and make contributions to it (provided the contributing spouse has contribution room).
Although the individual contributes to the spousal RRSP, it is their spouse who is entitled to the funds when withdrawn. Therefore, this allows both spouses to benefit from the use of their marginal tax brackets when withdrawing funds later in life. Note however that any withdrawals in the same year spousal contributions are made, or within the next two calendar years, will be attributed back and taxed in the hands of the contributing spouse (to the extent of those contributions).
Tax-Free Savings Accounts (TFSA) are not as beneficial from a tax-planning perspective as there is no deduction available for contributions. However, a TFSA is still a highly tax-efficient tool because investment earnings in a TFSA are not taxed at all (even when withdrawn).
Similar to RRSPs, it is possible for spouses to use TFSAs to split their income. Specifically, an individual can gift money to their spouse to contribute to their TFSA without any income or gains in the TFSA attributing back to the contributor. However, care must be taken when the spouse eventually withdraws from their TFSA – if they reinvest the withdrawn funds, income or gains on THOSE investments may be attributed back to the contributing spouse.
The maximum amount you can contribute to a TFSA in 2023 is $6,500 plus any unused contribution room from previous years. If you were born before 1992 and have never contributed to a TFSA, you have $88,000 of contribution room in 2023. There are strict penalties for overcontributions (1% per month of the over-contribution), so care must be taken to correctly calculate your contribution room.
You can generally withdraw amounts in your TFSA at any time without paying tax. If you withdraw an amount from your TFSA, you get that contribution room back, but not until the following January 1st, so be very cautious about withdrawing and recontributing funds.
Salary vs dividends from company
If you have a corporation, the end of the year is a good time to meet with your professional advisor to determine how best to pay yourself from the company.
For example, the company can pay you a salary or bonus (which is deductible to the company and creates RRSP contribution room), dividends (which are taxed at a lower rate than salary but are not deductible to the company and don’t create RRSP contribution room) or a mixture of both, depending upon your circumstances.
Some important considerations in this regard include: Has the company realized any capital gains in the year (half of which can be paid out to you tax-free as a capital dividend)? Do you already max out your RRSP contribution room by paying the maximum amount each year? Does the company’s income exceed the small business deduction limit of $500,000?
Income splitting with family
If you have family members who either provide services to your company, or are shareholders of the company, consider whether the company can pay amounts out to them by the end of the year to take advantage of any of their lower tax brackets which would otherwise not be used in the year.
This type of planning has been made extraordinarily difficult in recent years due to the introduction of the TOSI (tax on split income) rules, but may still be possible with correct professional advice.
For example, if a spouse or child has done some work for the company during the year, consider what the fair market value of that work is. Provided that any salary paid for that work is reasonable given the person’s contribution, it should be possible to pay out that salary without any negative implications.
Similarly, if family members are shareholders of the company, the company may consider paying dividends to those shareholders. As with paying a salary to family members, any dividend must be reasonable based on the shareholder’s contribution to the business; but you need to carefully analyse the TOSI rule in such a case.
Professional advice should always be sought before making payments to family members, either personally or from a company.
Upcoming business transfer?
Unique to the 2023 year-end, if you are thinking about passing all or part of a business to the next generation in the near future, consider whether it may be worth accelerating this business transition.
Current rules allow you, in certain circumstances, to transfer shares to an adult child and claim the benefit of your lifetime capital gains exemption (LCGE) without giving up outright control of the business. This could mean close to $1 million of value of any shares transferred being tax-free in your hands.
This is still available after 2023, but the rules are changing in 2024, significantly restricting the availability of the LCGE when passing on a business to a child.
Time is quickly running out to transfer shares under the current rules. The planning required is complex and time-consuming. Consult with your advisor as soon as possible if you think this planning may be possible for you.
More details on this planning, and the upcoming changes, were discussed in the July 2023 Tax Letter.