Tim Cestnick is managing director at WaterStreet Family Wealth Counsel and author of 101 Tax Secrets for Canadians.
Last weekend I was walking through the mall with my son, Michael, when he shouted: "Dad! Look at that man, he doesn't have any hair. None!" "Shhh, Michael," I said. "He might hear you." "So, what's wrong with that?" Michael wondered. "Doesn't he know his hair is gone?"
One of the joys of parenthood is teaching kids about life. I'm looking forward to the day when Michael and I can take a long walk and talk about the world of tax planning and registered retirement savings plans (RRSPs). My parents never did that for me at a young age. I think I missed out. Not my kids; they're going to know the fun to be had in tax planning.
The first thing I'll do is explain to my kids the benefits of filing a tax return. It's not just about the excitement of adding columns of numbers. No, it's much more than that. It's about cold hard cash in their pockets. Now, that's something my kids have come to appreciate. Let me share with you a true story that can set your own children or grandchildren on the right track to financial education and health.
When my nephew, Lincoln, was 14 years old I encouraged him to file a tax return for the first time. Now, if a person's taxable income was under $9,600 in 2009, there generally won't be a requirement to file a tax return (there are exceptions) since it's not likely any income tax will be owing thanks to the basic personal tax credit. Still, it can make sense to file a return. And this is what my nephew Lincoln did eight years ago at the age of 14.
Even though Lincoln had earned just $2,000 that year, filing a tax return did a couple of things for him: First, he learned about the real world of income taxes. Second, he created valuable RRSP contribution room which is about to save him tax dollars when he files his tax return for 2009.
You see, when Lincoln was 14, he filed a tax return and reported $2,000 of income that year. He paid no tax thanks to the basic personal tax credit, but he created $360 of RRSP contribution room that year. Beginning in 2003, Lincoln started working part-time in his father's business. His father agreed to pay him $6,000 each summer to work in the business, to help save money for university. Lincoln didn't pay any tax on the money he earned in those summers because his basic personal tax credit was always higher than his earnings. In addition, Lincoln added to his RRSP contribution room simply by filing a tax return each year.
In 2009, Lincoln graduated from university and started working full time. Thanks to his prior tax filings, Lincoln entered the work force with $8,000 of RRSP contribution room in his hands. This week, Lincoln made an $8,000 contribution to an RRSP for himself. This will save him taxes of $2,492 when he files his tax return for 2009, at his marginal tax rate of 31.15 per cent (the rate in Ontario at his income level of $41,000). This contribution will also give him a great head start in saving for retirement. He has time on his side, so he needs to take advantage of it. In fact, that single $8,000 RRSP contribution could be worth about $219,000 at Lincoln's age 65 if he earns 8 per cent on that money over the long term.
Here's the moral of the story: Ensure your children and grandchildren file tax returns each year regardless of how little income they earn. Now, keep the following in mind:
A student will be able to earn up to $10,320 in 2010 without paying any income tax thanks to the basic personal tax credit.
The tax-free earnings can be even higher if the student has tuition, education and textbook tax credits available to shelter even more income from tax. It's quite possible that a student could earn up to $20,000 annually before any taxes are owing after all these tax credits. In this case, Lincoln's father could have paid him even more to work in the business, providing a tax deduction to the business and avoiding tax in Lincoln's hands.
If your child opens an RRSP account and makes a contribution prior to joining the work force full-time, he should consider holding off on claiming the RRSP deduction until then. This will likely save him more tax.