Week 3 Budget Taxes and Savings

Introduction

Remember Tomomi from Week 2? You learned she has five revenue streams works on contract as a graphics designer, tutors on the side, does childcare in the summer, and buys and sells anime collectibles.  Every year, Tomomi deposits $1,000 into her RRSP and whatever cash is left over after she has paid her bills is saved in a high-interest savings account and invested in her tax-free savings account.

Like so many of us, Tomomi struggles to make ends meet. With historic levels of wage stagnation, increasing rents and high costs of living, Tomomi doesn’t have much left over at the end of the month. She doesn’t collect a regular pay cheque so her income fluctuates month over month. She saves whatever little money she can in two savings accounts, one an Registered Retirement Savings Plan (RRSP) and the other, a Tax-Free Savings Account (TFSA). Saving to build wealth is investing. When people have too much money to spend immediately—that is, a surplus of disposable income—they become savers or investors.

Investing happens over your lifetime. In your early adult years, as we see in Tomomi’s case, you typically have little surplus to invest. After a period of just paying the bills, making your rent, and trying to put something away for retirement, you may have the chance to accumulate wealth. Your income increases as your career progresses. You have fewer dependents (as children leave home), so your expenses decrease. You begin to think about your investment options. You have already been investing—in your home and retirement—but those investments have been prescribed by their specific goals.

You may reach this stage earlier or later in your life, but at some point, you begin to think beyond your immediate situation and look to increase your real wealth to ensure your future financial health. Investing is about that future.

You can see how Tomomi is saving, even small amounts, to help her survive ‘rainy days’ and plan for her retirement.

Tax advantages are sometimes created for personal financial strategies as a way of encouraging certain personal goals. In Canada, for example, home ownership, retirement savings, and education are seen as personal goals that benefit society as well as the individual. In most cases, tax advantages are created to encourage progress toward those goals.

Retirement saving is encouraged, so some savings plans such as a registered retirement savings plan (RRSP) or a registered pension plan (RPP) create tax advantages. For example, an RPP is a pension plan that has been set up by your employer, and registered by the CRA, in order to provide you with a pension upon retirement. You can deduct the total of your RPP contributions to reduce your taxable income. Income from this plan will be taxed at a later date.

 

There are also retirement savings strategies that do not create tax advantages, such as saving outside of a tax-advantaged account. A tax-free savings account (TFSA) is a flexible investment account that can help you meet both your short- and long-term goals. Your investment income in a TFSA—interest, dividends, or capital gains—is not taxed, even when withdrawn. This tax-free compound growth means that your money grows more quickly inside a TFSA than in a taxable account. In addition to the investment income earned, any amount contributed to the TFSA is not taxed when it is withdrawn. However, initial contributions to a TFSA are not deductible for income tax purposes. The following are important facts about contributions to your TFSA:

• The current contribution limit is $5,500 per year; contributions to your RRSP/RPP do not limit your TFSA contribution.
• Any unused room can be carried forward.
• You can contribute up to your TFSA contribution limit. A tax applies to all contributions exceeding your TFSA contribution limit.
• Withdrawals will be added to your TFSA contribution room at the beginning of the following year.
• You can replace the amount of the withdrawal in the same year only if you have available TFSA contribution room.
• Direct transfers must be completed by your financial institution. (Government of Canada, 2016)

Another important element for Tomomi is the sales tax or consumption tax taxes the consumption financed by income. As you learned earlier, in Canada, sales taxes are imposed by the federal and provincial governments. In Canada, there are three types of sales taxes:

1. Provincial Sales Tax (PST): currently collected in British Columbia, Saskatchewan, Manitoba, and Quebec.
2. Goods and Services Tax (GST): a value-added tax (general consumption tax) levied by the federal government on most products except for essentials such as groceries, rent, and medical services. GST is an example of an excise tax, an indirect tax imposed on the sale of a particular product.
3. Harmonized Sales Tax (HST): also a value-added tax that is a single, blended combination of PST and GST, collected by Ontario, New Brunswick, Newfoundland and Labrador, Nova Scotia, and Prince Edward Island.

The value-added tax (VAT) or GST is a consumption tax, but it differs from the sales tax, which is paid only by the consumer as an end user. With a VAT or GST, the value added to the product is taxed at each stage of production. Governments use a VAT or GST instead of a sales tax to spread the tax burden among producers and consumers, and thus to reduce incentive to evade the tax. A consumption tax is a regressive tax. When travelling abroad, you should be aware that a VAT may add substantially to the cost of a purchase (i.e. a meal, accommodations, etc.).

Tomomi needs to consider including the PST, GST or HST to her invoices to collect that tax so she doesn’t wind up with a nasty surprise near tax time in the spring at the end of April each year.

Self-Employment Taxation Keywords

GST/HST

Goods and Services Tax (GST)/Harmonized Sales Tax (HST)

GST/HST – 12 month period
If you made more than $30,000 in ANY 12 month period ENDING in the current year, you must register for GST/HST. For example, since we are in 2022, let’s look at 12 month periods ending in 2022. One example is January 1 to December 31, 2022.

GST/HST – Tax Return
Yes, you have to file a GST/HST tax return. The government will tell you once it’s due.
It’s very simple and only requires you to only share:

• How much you made
• How much GST/HST you charged
• How much GST/HST you paid on business expenses
• Finally, you pay the GST/HST you have been collecting on your self employed income (unfortunately, it’s not yours!)

RRSPs

RRSPs are Registered Retirement Savings Plans. You can use them to save for your retirement.

Limits: Your RRSP contribution limit for any year is 18% of earned income you reported on your tax return in the previous year, up to a maximum of figure (which changes every year).
If you don’t use your contribution room, it rolls forward and you can use it in a future year.

TAX BENEFIT: when you contribute to an RRSP account, you get a tax deduction when you contribute.

Deadlines: In order to get an RRSP deduction in the current year, you can contribute any time during the year starting on March 1 and upto the first two months of the following year. For example – in 2021, you can contribute any time from March 1, 2021 to February 28, 2022. In 2022, you can contribute any time from March 1, 2022 to February 28, 2023.

Generally, once you put money in your RRSP, you shouldn’t plan to take it out. UNLESS you fall into any of the two exceptions:

• Exception 1: First time home buyer’s plan
• Exception 2: Lifelong learner’s plan
• TFSAs
• TFSA are Tax Free Savings Accounts

That means you can earn money inside an Tax Free Savings Account and NEVER pay taxes on those earnings.
In any other non-TFSA account, you have to pay taxes on earnings.
So why doesn’t everyone ONLY use TFSAs to earn money on their savings?!

Because there are government-sanctioned limits on how much money you can have in your TFSA you are limited to how much you can contribute.

• The annual TFSA dollar limit for the years 2009 to 2012 was $5,000
• The annual TFSA dollar limit for the years 2013 and 2014 was $5,500
• The annual TFSA dollar limit for the year 2015 was $10,000
• The annual TFSA dollar limit for the years 2016 to 2018 was $5,500
• The annual TFSA dollar limit for the years 2019 to 2022 is $6,000

TFSA contribution room accumulates every year, if at any time in year you are the age of majority or older and a resident of Canada, you can open an account. Your contribution room starts accumulating from the time you are 18 years old.

If you don’t use your contribution in any year that you were eligible to, it carries forward.