9.5 Strategies for Tax Efficiency
Key Takeaways
Interest on money borrowed to invest is deductible only for non-registered, income-earning investments, not for RRSP or TFSA contributions; leveraging magnifies losses as well as gains.
Income and capital gains on property given or lent to a spouse are attributed back to the giver; for gifts to minor children only income (not capital gains) is attributed; gifts to adult children are not attributed.
A prescribed-rate spousal loan avoids attribution if interest at the CRA prescribed rate is paid by January 30 each year.
Charitable donations earn a federal credit of 15% on the first $200 and 29% above (33% on donations from income in the top bracket); spouses can pool donations and medical expenses.
Tax deferral tools include RRSPs and spousal RRSPs (deduct now, tax later), TFSAs (tax-free growth) and RRSP-based strategies such as the Home Buyers' Plan ($60,000) and the Lifelong Learning Plan.
Strategies for Tax Efficiency
A good recommendation considers what the client keeps after tax. The curriculum groups tax-efficiency strategies into four families.
1. General Strategies
Leveraging (Borrowing to Invest)
- Interest deductibility: interest on money borrowed for a non-registered investment may be deductible under ITA s. 20(1)(c) when the direct use of the borrowed money is to earn income from business or property. A reasonable expectation of dividends, interest or other income is required; an investment expected to produce only capital gains does not qualify. Interest on money borrowed for an RRSP or TFSA contribution is not deductible.
- Risk: leverage magnifies both gains and losses; the loan must be repaid even if the investment falls.
- Regulatory expectations: under the CCIR/CISRO Segregated Funds Guidance, an agent who recommends borrowing to invest in an IVIC must, before the application, give the client a risk disclosure document on borrowing to invest, disclose any conflicts (such as referral fees on the loan), and provide a written leveraging strategy covering the loan terms, repayment, the investment options and the return needed to break even. The agent then reviews the strategy at least annually, and updates the client's KYC information each year.
Income Splitting
Moving taxable income from a high-income spouse to a lower-income one reduces the family's total tax:
- Spousal RRSP contributions (respecting the three-year attribution rule on withdrawals).
- Pension income splitting from age 65 (up to 50% of eligible pension income, including RRIF and registered annuity payments).
- CPP pension sharing between spouses.
- Prescribed-rate spousal loan: the higher-income spouse lends money at the CRA prescribed rate in effect when the loan is made; if the borrowing spouse pays the interest by January 30 of each following year, the investment income is taxed to the borrower.
- The higher-income spouse paying household expenses so the lower-income spouse can invest.
Gift Strategies and the Attribution Rules
| Gift or loan to... | Income (interest, dividends) | Capital gains |
|---|---|---|
| Spouse or common-law partner (gift or low-interest loan) | Attributed to the giver | Attributed to the giver |
| Minor child, niece or nephew (under 18) | Attributed to the giver until the child turns 18 | Not attributed (taxed to the child) |
| Adult child | Not attributed (unless a loan made to split income) | Not attributed |
| Spouse's TFSA contribution | Not attributed | Not attributed |
Growth-oriented investments (taxed mainly as capital gains) are therefore better for gifts to minor children, and gifts to a spouse's TFSA are a simple way to split investment income.
2. Credits and Deductions
- Charitable donations: the federal credit is 15% on the first $200 of donations in a year and 29% on the rest (33% on the part donated from income taxed at the top federal rate), plus provincial credits. Spouses may pool donations on one return, and donations can be carried forward five years.
- Using credits in the higher- or lower-income spouse's name: pool donations with the higher-income spouse (to reach the higher rate faster); claim medical expenses on the lower-income spouse's return, because the claim is reduced by 3% of net income (to an annual cap).
- Tax-advantaged returns: for a non-registered account, Canadian eligible dividends (gross-up and dividend tax credit) and capital gains (half taxable) are taxed more lightly than interest. Hold interest-producing funds inside RRSPs and TFSAs and equity funds in non-registered accounts when possible.
- Interest deductibility on leveraging applies only to non-registered plans, as noted above.
3. Insurance-Specific Strategies
- Prescribed annuities: level taxation of non-registered annuity income, with most of each payment treated as a tax-free return of capital. This keeps net income low, protecting OAS and income-tested credits.
- Insured annuities: a prescribed life annuity plus permanent life insurance gives higher after-tax income and a tax-free death benefit for heirs (see section 8.4).
- Segregated fund allocations: capital losses flow to the policyholder and can offset gains elsewhere; a named beneficiary avoids probate fees on the death benefit.
4. Tax Deferral Plans
| Plan | How it saves tax | Best for |
|---|---|---|
| RRSP | Deduction at the contributor's current rate; tax deferred until withdrawal | Clients in a higher bracket now than expected in retirement |
| Spousal RRSP | Deduction for the higher earner; income taxed to the lower earner later | Couples with unequal retirement incomes |
| TFSA | No deduction, but growth and withdrawals are tax-free and do not affect OAS/GIS | Lower-income savers, retirees, and anyone who has used RRSP room |
| Home Buyers' Plan | Withdraw up to $60,000 from an RRSP tax-free for a qualifying home, repay over 15 years | First-time buyers with RRSP savings |
| Lifelong Learning Plan | Withdraw up to $10,000 a year ($20,000 total) for full-time education, repay over 10 years | Adults returning to school |
RRSP vs. TFSA rule of thumb: if the tax rate when the money is withdrawn will be lower than the rate when it was contributed, the RRSP wins; if it will be the same or higher (or OAS/GIS clawbacks will apply), the TFSA usually wins.
5. Case: Building a Tax-Efficient Recommendation
Marc (marginal rate 46%) and Aline (marginal rate 20%), both 52, have $150,000 in non-registered savings, unused RRSP room for Marc and unused TFSA room for both.
- Marc contributes to a spousal RRSP for Aline: the deduction saves tax at 46%, and the money will be taxed later in Aline's hands.
- Both use TFSA room for an emergency fund and balanced funds.
- In the non-registered account, they favour equity and dividend segregated funds (taxed lightly) and keep bond funds in registered plans.
- Marc gives money to Aline for her TFSA contributions, with no attribution.
- They pool charitable donations on Marc's return and claim medical expenses on Aline's.
- Borrowing to invest is not recommended: the couple has no need to take extra risk.
Paolo borrows $50,000 to invest. In which case is the interest on the loan generally deductible?
When he uses the loan to make an RRSP contribution
When he uses the loan to invest in a non-registered segregated fund that can earn income
When he uses the loan to contribute to his TFSA
When he uses the loan to pay for a family vacation
Gloria gives $20,000 to her 12-year-old grandson, who invests it in an equity fund. The fund produces $300 of dividends and a $2,000 capital gain this year. How are these taxed?
Both the dividends and the capital gain are taxed to the grandson
Both the dividends and the capital gain are attributed back to Gloria
The dividends are attributed to Gloria, and the capital gain is taxed to the grandson
The capital gain is attributed to Gloria, and the dividends are taxed to the grandson
Which spouse should normally claim the couple's medical expenses?
The higher-income spouse, because the credit rate is higher for higher incomes
The lower-income spouse, because the claim is reduced by 3% of net income (up to an annual cap)
Neither; medical expenses must be split equally between the spouses
Whichever spouse is older, regardless of income
Sections you finish are checked off in the contents.