Four ways to grow your wealth tax-free in Canada

The introduction of the new First Home Savings Account (FHSA) on April 1, 2023, provides another way Canadian residents can potentially grow their wealth tax-free in Canada.

Principal Residence Exemption (PRE)

Possibly one of the most cherished tax benefits by Canadian residents, the PRE provides for tax-free growth on the value of one real property, which for many Canadians is their principal home.

The PRE may eliminate or reduce a capital gain realized on the disposition, such as a sale, or deemed disposition, such as at death, of a property you own designated as your principal residence. If any capital gain realized is eliminated by claiming the PRE, this provides for tax-free growth on the value of your principal residence.

For a property to qualify as a principal residence, it must generally meet the following conditions:

  • it is a housing unit, which can include a house; an apartment or unit in a duplex, apartment building, or condominium; a cottage; a mobile home; a trailer; or a houseboat; among others,
  • you own the property (either solely or jointly with another person),
  • the housing unit must be “ordinarily inhabited” in the year by you, your current or former spouse or common-law partner, or any of your children, and
  • you designate the property as your principal residence for the year, and no other property has been so designated by you or any member of your family unit for the same year.

If you own multiple properties, such as a house and a cottage, and both properties otherwise meet the criteria noted above for being your principal residence, you may only designate one property per year as your principal residence. Generally, in years where you own more than one property, it is typically more advantageous to claim your PRE on the disposition of the property with the higher capital gain per year.

Tax-Free Savings Account (TFSA)

Canadian residents aged 18 and older may contribute to a TFSA. Unlike a Registered Retirement Savings Plan (RRSP), TFSA contributions are not tax-deductible. Rather, all investment income and returns earned within a TFSA are tax-free. The annual maximum TFSA contribution amount is $6,500 in 2023 and is indexed to inflation and rounded to the nearest $500 annually. Any unused contribution limit may be carried forward to future years. There is no deadline to make a TFSA contribution. The accumulated limit since 2009, when the TFSA was launched, and if you were 18 and older at that time, is currently $88,000.

TFSA withdrawals can be made at any time tax-free. Generally, the withdrawn amount may be recontributed to the TFSA in the following calendar year unless you have unused TFSA contribution room in the year of withdrawal.

TFSAs may be used for short-term or long-term savings. Typically, when you are younger, you may benefit from using TFSAs for saving for life events such as a new vehicle, vacations, weddings, or as part of a down payment on a first or new home. As you get older, you may benefit from using TFSAs to help fund your retirement or as a strategy to transition your wealth to the next generation tax-free.

First Home Savings Account (FHSA)

Canadian residents aged 18 and older who are qualifying prospective first-time homebuyers may open and contribute to an FHSA. The FHSA, new as of 2023, provides for the ability to save up to $40,000 on a tax-free basis towards purchasing a first home in Canada.

Like an RRSP, contributions to an FHSA are tax-deductible, but withdrawals, including all investment income and returns, to purchase a qualifying first home are non-taxable, like a TFSA. An FHSA essentially combines the benefits of an RRSP and a TFSA in one account.

The annual maximum FHSA contribution amount is $8,000, and any unused contribution limit may be carried forward to future years. Notably, any carryforward amount only accumulates after you open an FHSA for the first time. This attribute leads to a planning consideration for the FHSA – even if you cannot contribute, you may consider opening an FHSA as an early first step in your home buying planning to begin accumulating carryforward contribution room. The maximum amount of unused FHSA contribution room that can be carried forward to a subsequent year is $8,000, which means that for any year after the year in which you open an FHSA, the maximum FHSA contribution room may be upwards of $16,000 ($8,000 carried forward contribution limit plus $8,000 current year contribution limit). The FHSA can remain open for up to 15 years or until the end of the year when you turn 71 years old. The FHSA must be closed by the end of the year following the first qualifying withdrawal, and you are not permitted to have another FHSA in your lifetime.

You may only use an FHSA if you qualify as a prospective first-time home buyer saving for your first home. Notably, any funds not used towards a qualifying first home purchase can be transferred to an RRSP or Registered Retirement Income Fund (RRIF) penalty-free and tax-deferred without impacting the taxpayer’s RRSP contribution room. Funds transferred to an RRSP or RRIF become subject to the rules applicable to those plans. Funds can also be withdrawn from an FHSA on a taxable basis if not required for a first home purchase. These transfers will not affect your RRSP contribution room, nor will they reinstate your $40,000 FHSA lifetime contribution limit.

Permanent Life Insurance

There are two types of life insurance – term and permanent. Term life insurance provides financial protection from premature death for a specific duration. It may be equated to car or home insurance: if you pass away during the coverage period, your death benefit will be paid out; if you do not pass away during the coverage period, the premiums paid provide financial peace of mind for only that time.

Alternatively, permanent life insurance may be equated to an investment. Generally, every dollar invested in permanent life insurance, plus investment income and returns, is paid out as a tax-free death benefit upon your passing. Permanent life insurance, whether whole or universal life, may be considered an alternative investment class as part of your investment portfolio. It provides two unique features – a tax-free death benefit and a tax-free investment account held inside the policy.

Permanent life insurance may be used to tax-efficiently save for a projected income tax liability resulting on the deemed disposition of all your assets upon your passing. In addition, it may be used as a tax-efficient means of transferring wealth intergenerationally, both personally and corporately. It may also be used as an estate equalization strategy when transferring a business or illiquid assets to your heirs.

Once you have taken advantage of your FHSA, if applicable, own a principal residence in Canada and have fully maximized your TFSA, permanent life insurance is another wealth planning strategy to grow and transfer your wealth in a tax-free manner.

Summary

Everyone’s situation is unique, and not all general tax planning opportunities may benefit every person. Speak with your own tax advisor for further discussion and analysis and before implementing any tax planning strategies.

source https://rosenbergdri.ca/four-ways-to-grow-your-wealth-tax-free-in-canada/

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