The Motley Fool

Warning: Don’t Save in Your TFSA if You Want to Reduce Your 2020 Tax Bill!

Image source: Getty Images

The Canadian government gives many cash benefits and instruments to help you save on the tax bill. Take time out and plan your investments and taxes simultaneously as your investments can save you on the tax bill.

Two savings account that gives you a tax benefit 

The Canada Revenue Agency (CRA) allows you to plan your investments through two savings accounts that give you tax benefit:

  • Tax-Free Savings Account (TFSA)
  • Registered Retirement Savings Plan (RRSP)

In a TFSA, you can invest up to $6,000 in 2020, but you won’t get any tax benefit this year. Your TFSA contribution will be added to your 2020 taxable income, and any future withdrawals will be exempt from taxes. Hence, it is a good account to invest in high-growth and high-dividend stocks where your investment income is high. A TFSA is also good for people with low working income like students and retirees.

RRSP is for people with a high working income at the peak of their career. In RRSP, you can invest up to $27,230 or 18% of your earned income, whichever is lower, in 2020. You can deduct your RRSP contribution from your 2020 taxable income. However, your future withdrawals will be taxed. Hence, it is a good account to invest in long-term investments that you might want to withdraw after you retire and fall under the lower tax bracket.

How to reduce your 2020 tax bill 

This year, the CRA gave generous cash benefits worth $2,000 per month in the wake of the pandemic, irrespective of your income. However, there was one criterion that you should have earned at least $5,000 in working income last year. Even then, the Canada Emergency Response Benefit (CERB) increased the average household income by 10.8% in the second quarter.

The CRA will add CERB and the new Canada Recovery Benefit (CRB) to your 2020 taxable income. If you have been claiming these cash benefits consecutively since March 15, the benefits’ amount alone will add up to $19,400 ($14,000 in CERB and $5,400 in CRB). The addition of this benefits amount could increase the 2020 tax bill for many Canadians.

The CRA offers many tax breaks like personal amount and Canada employment amount that can help you reduce your taxable income. Even then if your tax bill is high, put your annual savings in RRSP and not TFSA.

Investment and tax planning go hand in hand 

Remember, expense management and investment and tax planning go hand in hand. If this seems overwhelming, follow this three-step approach:

First, calculate income and expenses for the year and set aside an amount for investment purposes. Keep some extra cash over and above your expenses for emergencies.

Second, calculate your taxable income after deducting all possible tax breaks. You need not get the exact amount. Even a rough estimate will do.

Finally, decide on your risk appetite and invest your money accordingly in dividend or growth stocks or other securities. In this step, you can choose whether to invest through TFSA or RRSP depending on your tax bill and how much money you have for investment.

For instance, Jane has $45,000 in taxable income after all deductions and around $7,000 for investment purposes. He will be better off investing this $7,000 in the security of his choice through RRSP. This way, he can reduce his taxable income to $38,000.

One good investment for your RRSP portfolio 

A good stock for your RRSP is Suncor Energy (TSX:SU)(NYSE:SU). The stock has dropped 63% this year as the pandemic awakened many bears for the oil stocks. The pandemic-induced travel restrictions grounded planes and significantly reduced demand for jet fuel, gasoline, and other petroleum products made from crude oil.

The oil prices dropped below the cost per barrel, and all oil companies posted billions of dollars in losses. Suncor cut costs, stopped production, reduced capital spending, and even cut dividends to lower losses. The first signs of recovery showed positive funds from operations for Suncor. It is this recovery on which Warren Buffett is betting and holding Suncor stocks.

The stock will recover and Suncor will increase dividends, but it needs patience, making it a good long-term investment.

You might also want to look at these stocks for your RRSP portfolio.

The 10 Best Stocks to Buy This Month

Renowned Canadian investor Iain Butler just named 10 stocks for Canadians to buy TODAY. So if you’re tired of reading about other people getting rich in the stock market, this might be a good day for you.

Because Motley Fool Canada is offering a full 65% off the list price of their top stock-picking service, plus a complete membership fee back guarantee on what you pay for the service. Simply click here to discover how you can take advantage of this.

Click Here to Learn More Today!

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 Puja Tayal has no position in any of the stocks mentioned.

Two New Stock Picks Every Month!

Not to alarm you, but you’re about to miss an important event.

Iain Butler and the Stock Advisor Canada team only publish their new “buy alerts” twice a month, and only to an exclusively small group.

This is your chance to get in early on what could prove to be very special investment advice.

Enter your email address below to get started now, and join the other thousands of Canadians who have already signed up for their chance to get the market-beating advice from Stock Advisor Canada.