Whenever you have a chance to defer paying tax, a common thought is, “Why pay tax now when I can pay it later?” However, there’s more to the story than simply postponing the tax bill.
Tax deferral offers three potential benefits. First, paying taxes in the future gives you more funds to meet your current financial needs. Second, the tax liability may be reduced if you have a lower marginal tax rate when the tax becomes payable. Third, when tax is deferred on investments, your investments have greater potential to grow and compound.
Depending on the tax deferral situation, one or more of these benefits may apply. Here are some common and less well-known tax deferral opportunities.
Building wealth
When you contribute to a Registered Retirement Savings Plan (RRSP), your tax deduction results in more disposable income to support your lifestyle now. In addition, your contributions grow on a tax-deferred basis for greater compound growth.
Even a non-registered account can offer tax deferral to a certain degree. Equity investments are only taxable when sold, so any investments you buy and hold for a longer period of time can benefit from greater tax deferral. Also, when you wish to sell an equity investment, you could defer the transaction to a year of lower income to reduce the tax on capital gains. However, note that you should not make investment decisions solely for tax reasons.
Selling property
The capital gains reserve can be claimed when selling capital property, such as a vacation property, stocks or mutual funds. You spread the sale over a maximum of five years, provided you and the purchaser agree. Instead of facing one large tax bill on capital gains, you’re able to pay smaller annual amounts—a strategy that potentially results in paying less tax overall.
Drawing retirement income
Your retirement income may come from a variety of sources, and one vehicle might be a mutual fund or other investment that includes a return of capital in its distributions. A return of capital is often desirable as retirement income because it’s not taxable, so you keep more of the distributions to support your retirement lifestyle. It’s also a form of tax deferral. You’ll eventually pay tax on capital gains either on your regular distributions many years down the road or when the investment is sold—and if your tax bracket is lower at that time, you pay less tax.
Preserving estate assets
Upon your passing, the tax liability on your registered retirement plan assets and non-registered capital property can be significant. However, the tax is deferred if you leave these assets to your spouse. This results in more assets available for potential growth and to provide for your spouse’s retirement.