Before I tell you about this trick, I have to admit: I don’t mind paying taxes. Canadians enjoy a lot of benefits from these taxes, including right now during a pandemic. When a vaccine is created for COVID-19, we don’t have to worry for paying for it. Nor do we have to worry about tests, treatment, or even government support in the form of the Canada Emergency Response Benefit (CERB) and the like.
However, if there is a way to keep some cash on hand, I’m all for it. I’m not about to lie on my tax return or anything, but I’m certainly going to pay attention when there is a way to keep my hard-earned money. After all, taxes are great, but right now taxes are high and likely to get much higher.
Luckily, there are a number of tools that are government approved to help you save on taxes. First off, there is of course the Tax-Free Savings Account (TFSA). This allows Canadians up to $69,500 in contribution room to invest, tax free. Then there is the Registered Retirement Savings Plan (RRSP), which is tax free until you withdraw that money for use, with a few exceptions.
Let’s get to that trick.
Step one: The TFSA
If you’re a millennial like me, maxing out on your TFSA contribution room doesn’t seem likely. But that doesn’t mean you should forgo investing altogether. Instead, start with a percentage to put away each paycheque. Even just 10% can make a huge difference. If you make the average salary of about $55,000, that $458 per month you can put towards investing! That’s also $5,500 safe from taxes in your TFSA.
The next step is to invest in the right stock. There are plenty out there, but for our purposes, I would recommend a company like Algonquin Power & Utilities (TSX:AQN)(NYSE:AQN) for millennials. That’s because it’s the perfect long-term hold with dividends to boot.
The company has a five-year return of almost 150% as of writing, growing through acquisition mainly at the moment. It’s also a safe bet, as the company provides utilities. No matter what, people need to keep the lights on, and the pandemic has created the only opportunity in company history where revenue has dropped thanks to business closures. With businesses opening again, this company is set to soar once more.
So, along with strong share growth, you’ll also receive a dividend yield of 4.56% as of writing. For that $5,500 investment, that would bring in about $188 in dividends each year. However, those dividends should grow by leaps and bounds, as the company recently slashed dividends due to the virus. Meanwhile, if the company continues on the same trajectory, you could be looking at growing that $5,500 into $8,393 in the next five years. That’s without investing dividends and without further contributions.
Step two: The RRSP trick
As we fast forward years from now, it’s likely you will enter a new tax bracket. You’ve moved away from that $55,000 and now make, say, $100,000 per year. That’s a huge increase in taxes. For the federal income tax alone, that’s a jump from 20.5% to 26%. Added onto that, of course, is your provincial or territorial taxes. Suddenly, you have to pay up!
All you have to do is take that chunk of cash in your TFSA and start putting some into your RRSP. What this does is take your taxable income right down. Say you were to take just $10,000 from your TFSA and put it into your RRSP, suddenly your taxable income is at $90,000 and you’re back to that 20.5% tax bracket, increasing your tax return.
As your income increases, you shouldn’t have to worry about giving it all to the government. By using this simple trick, you can keep increasing that 10% automatic contribution, knowing you have a solid, easy solution to keep as much cash on hand as possible.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.
Fool contributor Amy Legate-Wolfe has no position in any of the stocks mentioned.