A less taxing approach to planning

 A financial advisor smiles and discusses planning with a middle-aged couple.

Very simply, individuals are generally taxed by the government on the income they earn. Different tax rates apply to different levels of income. In addition, different types of income are effectively taxed at different rates.

So, for example, you may pay a higher marginal tax rate on the last dollar of employment income you earn than on the first dollar of employment income earned. We also effectively pay a different rate of tax based on the type of income in question. Regular income (including interest and employment income) is subject to the highest rate, while dividends are generally subject to a lower effective rate. Only 50% of a capital gain is included in income, resulting in an even lower effective tax rate, equal to half of the "regular income" rate.

There are things that will reduce the "total income" on which we pay tax (referred to as tax deductions) and things that reduce the "tax liability" we are required to pay (referred to as tax credits).

The same type of income may be taxed differently depending on whether it's held in a registered account versus a non-registered account. Income may even be completely exempt from tax, such as proceeds received on the sale of a principal residence. And in addition to income tax, there may be other types of tax to consider as well, such as probate tax.

Why does this all matter? Because understanding how we are taxed is a critical part of your financial plan. There are tax implications to nearly every decision related to investing, retirement planning, education funding, estate planning, and charitable giving. And there are planning implications every time a decision is made on the basis of "saving tax". These are neither necessarily good nor bad, and reasonable minds may disagree about how to weigh the relative pros and cons. One person may value tax minimization over simplicity, while another may choose minimizing risk over potential tax savings. Each of us will need to assess the relative value of a tax savings or other planning consideration to reach the best decisions for ourselves in our unique circumstances.

Let's look at some examples:

Jamie and Kelly were recently married. They opened a joint non-registered investment account and plan to each contribute $500 to the account every month. Jamie already had $50,000 of savings before marrying Kelly and has decided to transfer those savings into the joint account as well. At the end of the year they each plan to report 50% of the income from this account on their tax returns. What's the issue? Generally, investment income earned in a jointly held account is reported based upon how much each of the joint owners contributed to the account. The income earned on Jamie's larger contribution would need to be reported on Jamie's tax return, not Kelly's. What seemed like a straightforward savings strategy could create a tax reporting complication. Not to mention the potential implications of comingling assets from a family law perspective. It would be important for Jamie and Kelly to share with their financial advisor the source of the contributions and their goals for the funds. This will allow her to help identify issues and potential strategies in coordination with their tax professional and lawyer as appropriate.

Anni wants to minimize tax so she names her spouse as the beneficiary on her RRSP.  By doing so she believes the tax otherwise due on her death will be deferred, with the funds passing to her spouse on a rollover basis. Plus, she hopes to avoid the probate tax on the value of the account. Win win? Unfortunately, Anni's spouse does not get on well with Anni's children from a prior relationship. There is a risk that her spouse will choose not to put the RRSP proceeds into a registered account which could mean there may not be rollover treatment. Anni's estate could be liable for tax on the full value of the RRSP despite having named a spouse beneficiary. And the tax may need to be paid out of the estate assets Anni thought her children would receive. This unintended outcome could be avoided with proper advice from her lawyer, tax professional and financial advisor.

For many years Ben has volunteered with a charity that is near and dear to his heart. Each month he sends the charity $200. At the end of the year, Ben will claim a tax credit for the $2400 donation. Had Ben spoken to his financial advisor and tax professional he may have learned there are ways of making this donation that would have resulted in an even bigger impact to the charity and a greater reduction in his tax bill. Rather than donating cash he could have donated publicly traded securities with accrued gains. This could have eliminated the tax owing on the capital gain while still resulting in a donation receipt for the full fair market value of the securities.

It's important to recognize that there are often tradeoffs or unintended consequences to seemingly straightforward decisions. Together, your Edward Jones branch team can work with you and your tax and legal professionals to determine what’s best for your situation.

Important information:

Edward Jones, its financial advisors and its employees cannot provide tax or legal advice. This content should not be depended upon for other than broadly informational purposes. Individuals should consult a qualified tax advisor or lawyer regarding their circumstances.