Tax season is just around the corner, which means it’s time to get your financial house in order.
Contrary to popular opinion, there’s a lot more to keep track of during tax season than just getting your returns in on time. There are a number of steps you need to take in the lead up to filing that can make life harder on you if you neglect them.
This includes the obvious things, like gathering your receipts for all deductible expenses and getting all the proper forms ready to file. There are also some less obvious things that can have a huge impact on your tax bill. In this article I’ll be exploring one overlooked tax season mistake that can cost you big time when you go to file in April.
Making RRSP contributions for the wrong year
Making RRSP contributions is one of the big ways you can save on taxes. Every dollar you contribute to an RRSP lowers your taxable income, so the more such deductions you make, the less you’ll owe, which can result in a big tax refund after you file in April.
However, you need to make sure that you make your RRSP contributions for the right year. In 2020, the RRSP contribution deadline for the prior year is March 2nd. This means that if you make contributions after that date, they’re going toward your 2020 taxes, not your 2019 taxes.
Conversely, if you contribute up until that date, you may be contributing more than you expected for 2019, which could result in higher-than-expected taxes for 2020.
What to do
If you’re concerned about making RRSP contributions for the wrong year, the first thing you need to do is have the deadline clear in your head.
March 2nd is the deadline for 2019 RRSP contributions, so if you want to maximize your tax savings for next year, you need to contribute by that date. On the other hand, if you are working on building up tax deductions for 2020, you’ll need to wait until after that date to start making RRSP contributions.
Once you’ve got the date straight, the next thing to do is make the right investments in your RRSP. Remember: deductions aren’t the only tax benefit that come from investing in an RRSP. RRSP capital gains and dividends are tax-deferred, so you also save on those taxes by holding stocks in an RRSP.
One great investment to hold in your RRSP is the Vanguard S&P 500 Index Fund (TSX:VFV).
VFV is a highly diversified index fund based on the S&P 500–the 500 largest stocks in the U.S. by market cap. Over the years, the S&P 500 has delivered solid capital gains, while also paying a bit of dividend income. So, when you hold it in an RRSP, you get the potential for significant returns, which are all tax-deferred.
The S&P 500’s solid track record of capital gains is a strong enough reason to consider it.
However, there’s another specific reason to hold it in an RRSP–one that adds a third tax benefit on top of the deductions and tax-deferment you get on all RRSP investments — withholding tax exemption.
Normally, U.S. dividends paid to Canadian shareholders are taxed by the IRS. However, if you hold the Vanguard fund in an RRSP (under the U.S ticker “VOO”), the IRS will exempt you from that withholding tax.
That means you’ll collect the full dividend on your VOO units, which would be taxable in virtually any other Canadian investment account. This makes the RRSP the perfect investment vehicle to get your exposure to U.S. ETFs.
