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Why paying more tax today may lower your overall bill

Contrary to conventional wisdom (and some advice from accountants and tax software), getting your 2010 taxes to be as low as possible is not necessarily good tax planning. It looks good on paper, but to truly be tax efficient, you need to think beyond this year.

Here are three examples of short-term tax planning strategies that may cost you thousands in lifetime taxes:

1) Refusing to withdraw money from your RRSP until you are forced to at 71.

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In many cases, people don't take money out of their RRSP in their 60s because it will increase their tax bill in that year. The mistake is that they could have taken funds out in a low income year (maybe even moved the funds into a TFSA so they would still be tax sheltered), but by not taking funds out now, the same RRSP assets may be taxed at a higher tax rate in the future or as part of their estate if they have a large RIF balances when they die (assuming they are single or the last survivor of a married couple). In other cases, by not taking the funds until they are in their 70s, the forced RIF withdrawal becomes larger in the future and may put their income beyond the Old Age Security threshold.

The main point is that without doing a long-term plan, it is difficult to know if it makes sense to put off an RRSP withdrawal for the future or to take a withdrawal now.

2) Always putting off taxable capital gains as long as possible.

This often makes sense; however, if you are in a low-income situation in a particular year, it may make sense to take the capital gain now, and not put it off.

As an example, if you have a $10,000 gain on a stock and sell it, your capital gain tax could be $2,300 (23 per cent in Ontario) if the sale takes place in a year when you are in the top marginal tax bracket. If, instead, you are in a much lower tax bracket in a particular year, the tax bill on the same stock sale may be $1,200. If your income is steady every year, you should ideally defer capital gains taxes, but if your income fluctuates, try to time taking the capital gain in a year with low income.

3) Always getting the tax refund from your RRSP contribution.

Similar in some ways to the first example, it doesn't always make sense to claim an RRSP contribution in a low-income year - even though it will always lower your current tax bill. Let's say you make $35,000 this year, but next year you expect to make $90,000. You can still make an RRSP contribution to get the tax sheltering this year, but it is better to carry forward the deduction until the next year. In this example, you could get an extra 23 per cent refund by waiting one year to claim the deduction. That is a pretty good return in any year.

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In all of these cases, having a much better understanding of your long-term financial picture could lead to different decisions on your 2010 taxes. It may just be that your road to lower lifetime taxes comes with a higher tax bill today.

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