Dale Barrett - Pay WAY Less Tax!: 250+ Deductions, Credits & Tips from a Leading Tax Lawyer

The analysis of money and time is paramount in financial decision making. Time value of money concepts such as present value of money vs. future value of money are used to calculate and to compare the values of sums of money at different points in time.

The time value of money refers to the fact that a dollar today is worth more than a dollar in the future (due to inflation). We all know this intuitively. What you can buy for one dollar today will cost you much more than a dollar in the distant future. Similarly, what you can buy for a dollar today would have cost much less than a dollar in the past.

Consider the following example: Assume somebody owes you $100. You would rather get the $100 now than in 5 years time. This is intuitive to us all. On one hand, the $100 bill is worth $100 both now and in 5 years time. But because of inflation the $100 bill will buy you less in 5 years than you could buy now. Similarly, if you invest the $100 bill now, it will be worth more than $100 in 5 years time.

The future value of a dollar is simply what the dollar, or any amount of money, will be worth if it earns interest for a specific time. So, if you got the $100 now rather than in 5 years, the future value of that $100 in 5 years will be more than $100.

Tax deferral is a common tool used in tax planning. It refers to delaying paying tax into the future. Instead of paying the tax now, but paying the tax in the future, you can hold onto your money now, invest it and allow it to grow. Plus, you can pay the tax debt in the future with money which is worth less than today. As discussed earlier, due to inflation a $100 bill in the future is worth less (and has less buying power) than $100 now. So, if one has a tax debt of $100 it is better to pay it with $100 future dollars rather than $100 today dollars. In other words, it is better to defer the payment of the tax until the future. And if you can hold onto the $100 for a while and invest it until you have to pay it to the CRA, that is even better.

With investment vehicles such as the Registered Education Savings Plan (RESP) and the Registered Retirement Savings Plan (RRSP), rather than paying tax now with today dollars, taxpayers can choose to pay tax on income in the future at a time when they are subject to a lower marginal tax rate.

The RESP and RRSP are the most common vehicles for the average Canadian to benefit from tax deferral. With an RESP, a subscriber contributes income and in turn interest, dividends, and capital gains are earned within the RESP. When the money is finally withdrawn, it is taxed at the low marginal tax rate of a student enrolled in an eligible higher education program such as a university, college or trade school. An added benefit of an RESP is that the Canadian Government will include up to $7,200 as a no-strings-attached grant in an RESP. Up to $500 a year can be received as a grant depending on what the subscriber contributes into the account annually.

An RRSP is another popular vehicle for Canadians to benefit from tax deferral. With an RRSP, taxpayers can deduct the amount that they invest from their tax returns. This means that no income tax is paid on the amounts invested. In turn, the investment can grow tax deferred inside the RRSP. Similar to an RESP and a Tax-Free Savings Account, there are massive financial benefits to tax sheltered compounding. Although tax is paid upon withdrawal from an RRSP, the taxpayer has control over when it is withdrawn. If a taxpayer retires at 65, and only has pension income (which places them in a lower marginal tax bracket than where they were pre-retirement), then they could save anywhere from 4-30% on each dollar withdrawn from the RRSP. This is notwithstanding that they have also benefited from earning tax sheltered income on a pre-tax investment.

In a nutshell, an RRSP helps reduce taxes in several ways.