Everyone knows that there are 4 seasons of the year; Spring, Summer, Fall, and Winter. However for nearly everyone, there is also a fifth season; tax season.

According to an article in theglobeandmail.com from 2019, the average Canadian household paid nearly $40,000 in taxes. In fact more was spent on taxes than living costs. If a family were to pay $40,000 in taxes on average every year for their 40 working years thats $1,600,000 in taxes.

Never mind the years of payable taxes in retirement and potential large tax bill upon death. However, with proper tax and estate planning, your tax paid over your lifetime can be greatly reduced.

This week we want to look at three truly tax-free investment vehicles; because who wants to pay more tax than they have to?

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Primary Residence

The primary residence is probably the largest and most common tax-free investment for most people. The tax-free nature is due to the principal residence exemption.

In order to receive the exemption, you must report the sale on your tax return (schedule 3) in the year of sale. If you forget to report the sale, it is import to ask CRA to amend that year’s return. Although they will not always agree, there are some circumstance where they do. However, a penalty may apply for the late designation.

The entirety of the capital gain on a property is only tax-free if it was the only principal residence you had for every year you owned it. This means that if you owned more than 1 property, for the same 20 years, you had to designate the same one as your primary residence every year.

It is important to remember that you do not have to designate the house you’re currently living in as your primary residence. This brings up a potential better use of the primary residence exemption.

If you own more than one property, it is best to designate the property that will increase in value the most as your primary residence. This means if you own a cabin and you expect it to appreciate twice as fast as your home, it could be worthwhile to designate the cabin as your primary residence.

Designating a primary residence can get complex when more than one property is in the mix. For this reason, consult your accounting and tax professionals. They will be able to assist you in which property should be designated and when.

It is important to note, that rental properties cannot be designated as a primary residence.

TFSAs

TFSAs are a great investment vehicle. Offering lots of flexibility and, as the name suggests, tax-free investment growth. In most situations, the TFSA is our preferred savings/investment vehicle of choice.

Contributions to a TFSA, unlike an RRSP, are made with after-tax dollars. This means there is no deduction for income tax purposes on contributions.

As you probably know from reading our previous articles, TFSA withdrawals do not increase your taxable income. This means that if a large unexpected purchase needs to be made, a TFSA withdrawal is a great solution.

Since we have talked about TFSA ad nauseam for more information be sure to read You Should Be Maxing Out Your TFSA.

Life Insurance

Life insurance can be quite complex. Their are many types of life insurance; whole life, universal life, term. Many ownership structures; personally owned, jointly owned, corporately owned, etc. As well as multiple components of the policy: premiums, riders, benefits, etc.

There are many situations where insurance is a great addition to a financial plan. There are also equally as many, where the cost of insurance is not worth it.

Both universal and whole life insurance policies can have an investment component. Depending on the terms selected, that investment component can be added onto the death benefit.

This can be extremely beneficial as the death benefit of most any life insurance policy is received tax-free by the beneficiary. It is important to consult a competent and knowledgeable insurance professional. Setting up an insurance policy incorrectly can have terribly adverse outcomes, large tax consequences, and can be difficult and costly to reverse.

Life insurance is not something we have mentioned frequently on our blog. However, we are trained life insurance advisors. So if you have any life insurance questions, or want a second opinion on your existing policy, let us know.

Conclusion

As you go through life, the payment of taxes is inevitable. However, by using the tax-free nature of a primary residence, TFSA, and Life insurance, you can greatly reduce your tax burdens. Before using any of the above tax-free investment options, it is prudent to consult your financial planning and tax professionals.

Sources:

https://www.theglobeandmail.com/business/article-average-canadian-household-spent-more-on-taxes-than-living-costs-in/#:~:text=Some%20information%20in%20it%20may%20no%20longer%20be%20current.&text=The%20average%20Canadian%20household%20paid,bill%20has%20changed%20over%20time.

8 questions about the principal residence tax