Know the score, keep the change

National Post

2008-07-19


Taxes not only affect what we take home each payday, but nearly every financial decision we make during our lives.

The most obvious example is investing. Being aware that interest income is taxed at full marginal rates while Canadian dividend income and capital gains when earned outside registered plans are taxed at much lower rates, can contribute significantly to overall portfolio design and asset allocation.

Yet another example of tax-based decision making is when an employee is considering leaving a job and exiting from a defined benefit pension plan. The employee has to make a choice: agree to take a pension later on from the plan or take a lump-sum "commuted value" amount, essentially an estimate of what the future pension benefits are worth today.

The commuted value can't be taken in cash but must be transferred to a "locked-in" type of retirement vehicle, which is usually subject to minimum and maximum annual withdrawals.

In the past, advisors would simply perform a mathematical calculation to determine whether an employee would be better off taking the monthly promised pension upon retirement or taking the theoretical lump-sum amount, investing it and hoping to beat the returns of the pension plan.

But with the introduction of pension income splitting last year, the decision becomes much more complicated. That's because, while both pension income and withdrawals from a locked-in plan qualify for pension splitting, the latter applies only upon reaching the age of 65 (whereas pension income can be split at any age).

As a result, a departing employee who is under age 65 and has a low-income earning-spouse may be better off taking an early pension and splitting it than taking a commuted value and waiting until age 65 to split it.

Taxes can even factor into the decision of how to pay for your daily commute. Take the cost of commuting on public transit in Toronto as an example: A one-way TTC fare is $2.75 for an adult commuter. Buying tokens in advance, in quantities of at least 10, drops the price to $2.25 per ride. Using tokens, the return fare to get to and from work is $4.50 a day.

Ignoring vacation days, with about 22 work days per month, the monthly cost of commuting is about $99 (or $121 if you pay cash). Compare that to a monthly pass, which costs $109, and it appears that you'd save $10 per month by choosing to purchase tokens instead of the monthly pass. This is where the relatively new federal tax credit for monthly transit passes kicks in.

This credit, which is not available for single-ticket fares, is equal to 15% of the cost of the monthly pass. Applying a credit of about $16 to the monthly cost of $109 brings the true cost of the pass down to $93.

Clearly, knowing about the tax rules can result in more cash in your jeans.