As we approach the end of the calendar year, we wanted to highlight seven strategies that may help to minimize your 2021 tax liability as it pertains to your investment portfolio. As some of these strategies are complex, you should consult with your financial advisor or tax planning specialist before undertaking.
1. Have you maximized your TFSA contribution for the year?
While the 2021 Tax-Free Savings Account (TFSA) contribution limit is $6,000, you may have unused contribution room if you haven’t maximized your contributions in previous years. If this is your first time contributing, you can contribute up to $75,500 if you have been over 18 and a Canadian resident since the TFSA was first available in 2009. If you have TFSA room available, you may want to speak with your advisor to find out if moving some of your investments from an open, non-registered (tax-exposed) account to a TFSA would be of benefit. Your advisor can help you assess the downside of triggering a potential capital gain versus sheltering all future income from taxes. In addition, he or she can help you through any transferred investments that have an accrued capital loss. A capital loss claim that occurs upon deemed disposition via transfer to a TFSA would be denied by CRA. In deciding what to do with respect to RRSP vs. TFSA, it’s important to weigh the enhanced flexibility in a TFSA versus the tax deductibility of an RRSP contribution. Timing, age, and marginal tax rates are additional factors to consider: while RRSP/RRIF withdrawals are fully taxable, TFSA withdrawals are tax-free. Remember, if you do plan to withdraw funds from your TFSA in the near future, consider doing so prior to the end of 2021. The amount of the withdrawal will increase the TFSA contribution room in 2022. Withdrawals increase future contribution room based on the value of the withdrawal itself; that new room, however, is only available in the subsequent calendar year.
Your advisor can help you make these choices.
2. Tax-loss selling
Tax-loss selling is a popular “silver lining” year-end strategy deployed to realize tax benefits associated with an underperforming investment. If your advisor or tax specialist tells you that you are holding securities in a non-registered account at the end of the calendar year that are valued at less than the adjusted cost base, a disposition prior to the end of the calendar year would result in a capital loss. In order to occur in 2021, the transaction must be posted three business days prior to December 31, depending on the fund of course. The capital loss can then be used to offset taxes owing on capital gains realized during the year or in any of the three prior taxation years if no capital gains have occurred in 2021.
You should talk to your advisor or tax specialist to understand the implications before engaging in any tax-loss selling. For example, if you want to be able to claim the loss, you must avoid triggering “superficial loss” rules. Assuming the security is being sold solely for tax purposes, a superficial loss occurs if you, or an affiliated taxpayer (typically a spouse) buys, or has a right to buy, the identical property during the period starting 30 calendar days prior to the disposition and ending 30 calendar days after the disposition. If your capital loss is deemed a superficial loss, it will be denied. Be mindful of all of the holdings within your affiliated group, along with their short-term buying intentions. Also, consider the opportunity cost of not being invested on top of transaction fees when using this strategy. Lastly, consider the overall investment merits of your sale as well as the time to settle.
3. Deferring realization of a capital gain
One common year-end tax strategy is to defer realized gains until the next calendar year. For instance, by deferring the sale of a security with an unrealized gain until January 1, 2022, the tax bill associated with the gain is not due until April 30, 2023. By taking advantage of lower graduated tax rates in separate calendar tax years, you can reduce the overall tax obligation. Other factors come into play as well. For instance, if the taxpayer is on maternity/paternity leave this year, they will likely be in a much lower tax bracket, so it would be optimal to realize a disposition in 2021. Also, be cognizant of changing tax rates from year to year including potential changes in the capital gains inclusion rate and increased tax rates, which may make deferral less attractive. Your advisor can help you understand if this strategy can work for you.
4. RRSP contributions – especially if you turn 71 this year
While you have until March 1, 2022 to make an Registered Retirement Savings Plan (RRSP)/spousal RRSP contribution, you may want consider contributing earlier to optimize tax-deferred growth. Your RRSP matures by end of the year in which you turn 71, with no additional contributions permitted thereafter. Typically, people choose to roll the funds into a Registered Retirement Income Fund (RRIF) by the end of that year.
If you do turn 71 in 2021 and you have earned income, it may be worth your time to make an over-contribution in December of 2021. There will be penalties associated with the contribution above the $2,000 over-contribution buffer, however once the calendar flips to January 1, 2022 your contribution room will increase based on your 2021 earned income. It will be critical for your advisor to assess your 2021 earned income figure so the over-contribution penalty tax only applies for December of 2021. The penalty tax is calculated based on 1% of the excess contribution per month. The additional tax savings from the RRSP deduction for 2021 will likely materially exceed the assessed penalty. If this over-contribution strategy is not used, the contribution room created via 2021 income will be lost. The contribution would need to take place prior to the RRIF conversion.
Note that spousal RRSP contributions are still available as long as the recipient spouse doesn’t turn 72 until 2022, assuming contribution room exists, regardless of the age of the contributing spouse.
5. RESP contributions
The lifetime contribution limit for Registered Education Savings Plans (RESPs) is $50,000. However, only the first $2,500 contributed annually will attract the maximum $500 annual Canada Education Savings Grant (CESG). If you make the entire $2,500 lump-sum contribution prior to the end of the year, your child can still access the full grant for 2021. The entire contribution plus the grant grows tax-deferred inside the registered account. The vehicle serves as a means for the child to access all of the contributed capital (including grants), plus growth on a tax-advantaged basis in the future, subject to qualifying education-related parameters.
Please note that $7,200 is the maximum lifetime CESG, which is only available up to age 18. If you are late to set up an RESP for a child, the carry-forward CESGs allow for a maximum of $1,000 in grants to be paid in any one year. This is particularly important in attempting to optimize the grants as the child gets older. If your child or grandchild turned 15 in 2021 and has never been the beneficiary of an RESP, for which at least $100 in annual contributions has been made for any four prior years (and not withdrawn), no CESG may be claimed in the future. If that is the case, in order to ensure future CESG claims are possible, there are two options. 1) $2,000 must be contributed to their RESP prior to the end of the year. 2) If there have been three prior years with contributions of at least $100, only $100 in RESP contributions will be required in 2021. There are additional benefits available for lower-income families on top of ancillary provincial based programs.
6. Charitable contributions
You can contribute to a registered charity by December 31, 2021 and receive a donation credit for your 2021 tax year. Be sure to obtain a tax receipt from the qualifying charity. Any eligible amounts given above $200 qualifies you for a higher federal credit rate of 29% (up to 33% for high income earners) versus 15%, so keep that threshold in mind. The provincial credit rates vary but generally increase at that threshold as well.
A popular alternative is to donate securities with an unrealized capital gain in-kind to a charity. If choosing between donating cash and such an investment, the security may be the more efficient option, as an in-kind disposition of this nature is tax exempt. You also receive a tax receipt for the fair market value of the security at the time of donation. Talk to your advisor to ensure that you account for the processing time to take advantage of such a strategy prior to year-end. And, check with them to ensure that the registered charity accepts donations of this nature. One option to enhance flexibility is to use an alternative vehicle known as a donor-advised fund. These widely available vehicles offer flexibility on the timing of the grants to the desired charity, but allow for an immediate tax credit.
7. Consider timing of investment purchases
Be aware of the distribution date for whatever mutual fund you may have on your radar, specifically within a non-registered context. Earnings in non-registered accounts are exposed to taxes. When it comes to mutual fund trusts or exchange traded funds (ETFs), taxable distributions will occur on distribution dates, which in many cases arise toward the end of the calendar year. Each distribution includes accumulated underlying realized income up to that date on a proportionate basis for investors. So, if you purchase a fund at a given time, you’re buying into the accumulated earnings in that fund.
For new purchases, ask your advisor if you should be considering buying after the distribution date in order to minimize your tax bill for the given year. One alternative in order to realize pro-rated distributions (only for the period for which you are invested) would be to invest in a segregated fund.
This article is meant only to provide high-level insights as an individual Canadian taxpayer approaches the end of the calendar year and does not constitute nor is a substitute for professional tax advice. Please ensure you work with your team of advisors to optimize your year-end tax position while considering all elements of your individual financial plan.
Information contained in this article is provided for information purposes only and is not intended to provide specific financial, tax, insurance, investment, legal or accounting advice and should not be relied upon in that regard. It does not constitute a specific offer to buy and/or sell securities. You should always consult your financial advisor or tax specialist before undertaking any of the strategies contained in this article. Information contained in this article has been compiled from sources believed to be reliable, but no representation or warranty, express or implied, is made with respect to its timeliness or accuracy and Sun Life Global Investments disclaims any responsibility for any loss that may arise as a result of the use of strategies discussed.
© SLGI Asset Management Inc., Sun Life Assurance Company of Canada, and their licensors, 2020. SLGI Asset Management Inc. and Sun Life Assurance Company of Canada are members of the Sun Life group of companies. All rights reserved.