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Spending What You’ve Saved – How Will This Affect Your Tax Bill?

by Evelyn Jacks

Tax season is a great time to take stock of how your personal efforts and after-tax results combine to give you the lifestyle you really want. If you have some specific goals for 2005 that involve tapping into accumulated assets, you may want to start planning now, and speak with your tax and financial advisors as you sign off on your return for 2004.

There are several life changes that may require the use of accumulated savings – births, deaths, marriages or divorce, to name a few. But how does one approach the decision to withdraw money from registered or nonregistered savings accounts, or to dispose of capital assets to fund such life-cycle changes with a most tax-efficient point of view? How will cashing in while you continue to accumulate savings affect your tax bill?

To preserve as much capital as possible, it helps to think about following a tax-efficient order of withdrawal, taking care to “realize” the least amount of taxable income possible. To manage this properly, you may wish to think of your savings within three distinct categories:

  1. Tax-assisted accumulations: The ultimate purpose of an RRSP is to fund specific income needs – during retirement, for example – when other actively earned income sources diminish or disappear. When the money is put in, you get a deduction for the capital, but take it out and both principal and earnings are taxable. But it is also possible to use the funds accumulating here on a tax-free withdrawal basis, to buy a home (under the Home Buyer’s Plan) or go back to post-secondary school (under the Lifelong Learning Plan). RRSPs also afford a great opportunity to equalize income in retirement with your spouse or common-law partner.
  2. Tax pre-paid assets: Any investments held in non-registered accounts, like shares, mutual funds and bonds, and revenue-generating properties are included in this category. These investments will have been made on a tax pre-paid basis – that is, no tax deduction is allowed when the principal is invested. Depending on the source of capital, your marginal tax bracket and market timing, it makes sense to plan to realize income from these sources on a diversified basis – making sure that desired after-tax results are attained with a good mix of interest, rents, dividends, capital gains, foreign or other taxable income sources. The plan is even more tax efficient when family incomesplitting opportunities are maximized.
  3. Tax-exempt assets: This can include your principal residence and other significant investment assets. When markets are right, it may make sense to sell or transfer these assets, or to tap into the equity built up in these assets by prudently taking an investment loan.

Here are some specific concepts you might wish to speak to your financial advisors about before you tap into these assets:

Tax-assisted contributions. Many people think about withdrawing money from their RRSPs first in times of stress or need. But remember the big red flag: both the principal and earnings must be added in full to your taxable income in the year of withdrawal. Do consider the Home Buyer’s Plan or Lifelong Learning Plan for tax-free withdrawals, but always remember that you will forfeit the opportunity to continue to grow this principal within the plan on a tax-deferred basis. Maybe that’s not a good place to start.

A much better plan, if your timing is right, could simply be to create new capital by making more RRSP contributions and claiming the tax deduction. For this to work, you need to be age eligible, have the contribution room, and have a net or taxable income to generate the tax benefits from the RRSP contribution. Ask your tax and financial advisors to calculate just how many new dollars you can create with new RRSP contributions before you think about taking money from these savings.

Remember too that you can often use the tax system to create new capital without coming up with any new money, by “flipping” assets held in a non-registered account into an RRSP. However, be aware that there will be tax consequences on the gains or losses at the time of disposition of those funds into the RRSP.

Finally, tax-efficient withdrawal strategies should take into account marginal tax rates during a taxpayer’s lifetime and at death. Sometimes it makes sense to withdraw funds and generate the tax during a taxpayer’s lifetime. For example, if your mom, a widow, will be in a higher tax bracket at the time of death (when remaining accumulations are added to income in full), she should obviously withdraw more taxable sums during her lifetime. But this could also affect refundable and non-refundable tax credits, and quarterly instalment payments, so proceed with caution.

Non-registered accounts. Income from property held outside registered funds is generally earned as interest, dividends, rents or royalties. These sums are reported for tax purposes according to a variety of rules, including:

  • Interest is reported on an annual accrual basis.
  • Actual dividends earned are reported as distributed, but must be grossed up by 25% on the individual return. A dividend tax credit then reduces taxes payable later on the return.
  • Rents are reported on a net basis after deducting operating expenses and applying capital cost allowance deductions to reduce net income to zero (losses cannot be created or increased with a CCA claim).
  • Royalties may be subject to special resource allowances.

In addition, any increase in value in capital assets held outside registered accounts will accrue on a tax-deferred basis until they are disposed of. Then only 50% of the gain will be taxable. Should you incur losses on the disposition of your capital assets, however, know that these are only deductible against capital gains, but may qualify for “carryover” provisions – that is, you can apply the loss against capital gains three years back and indefinately into the future.

To minimize tax consequences, you may be able to control when you generate the sale or transfer of assets (over two tax years, for example) or choose investments that allow you to blend the withdrawal of tax-pre-paid principal and taxable earnings – all with the goal of minimizing your overall tax cost.

Tax-exempt property. The majority of Canadian taxpayers also own some tax-exempt assets. This includes one principal residence per household, or it can include life insurance policies or even the shares of a qualifying small business corporation, which may qualify for a capital gains exemption of up to $500,000.

But, of course, dipping into those significant resources will only work if you are ready to sell and a willing buyer is present within your required time lines. If this is not the case, you may also be able to borrow against the equity in these assets, to leverage into new investment opportunities with tax-deductible investment loans. Speak to your advisor about a prudent approach that conforms to your risk tolerance level with this option.

Most important, because of our progressive tax rate structure under which lower earners pay less, discuss opportunities to transfer funds to family members to legitimately split investment income.

In short, depending on the diversity of your holdings, your marginal tax bracket, and your family tax filing profile, there are several options for income and equity creation to discuss with your financial advisors when you need extra resources to live your life to the fullest.


Evelyn Jacks is the author of 30 best-selling books on the subject of personal income taxation, and the President of Knowledge Bureau, Inc., Canada’s leading professional education publisher in the tax and financial services industry, specializing in delivering courseware and information services to knowledge-based practices. For more information call toll free 1-866-953-4769 or visit

This article is written to be of a general nature and neither the author, her company, employees, subcontractors or others associated with The Knowledge Bureau can take responsibility for any results, positive or negative, taken by any persons. While the author received a fee to write this article, she is not in the business of providing advice on investment products and is not registered and licensed to do so, nor does the author have any compensatory relationship, or beneficial ownership regarding the sale of investment products discussed herein

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