Wednesday, March 30, 2011

upwardly mobile

I know I'm supposed to be preaching advice toward the starving artist, but there comes a time in your life when you actually start making some money... Or your frugality and savvy market investing now has you a moderate or sizeable nestegg and from which you're living comfortably off the proceeds...  Either that, or you've gotten your act together and won an audition, got scouted, or been given the big break that you so desperately have been pining for all your life.

What happens now?

Well, your tax bracket is about to change...  Formerly you probably were like me only dishing out a few hundred bucks a year to the federal coffers and most of that would be for CCP (Canada Pension Plan) contributions.  Now you'll be up the creek without a paddle if you're not careful with your money!

Now, I know some of you might think this is just crazy talk seeing has you have been living hand-to-mouth for many years and any increase in income you have goes to paying off debts or stashed away in your investment accounts, rather than spent foolishly on those Italian shoes that were "calling your name" when you walked by the shop, or that shiny new iPad so you can impress all your friends when you bring it out on the town to show off.

But yes, the reality is that your taxes owed with be CRAZY relative to what you've been paying when you were poor.  So start stashing away 25% to 37% of your income into a separate savings account (as well as the 13% for HST) so when tax time comes around you won't be trying to come up with thousands of dollars you already spent!  (YES... THOUSANDS OF DOLLARS)

Don't forget to save all your receipts for anything and everything work related.  They can make a huge difference if you can manage to bump down your taxable income into the next lower bracket.  You'll have to surrender far fewer dollars to the government.

Also, as a self-employed individual, you should consider leasing equipment/cars etc. rather than outright purchases.  This way you get a bigger tax advantage for the stuff you'll need to do your craft and get you to your gigs.  Yes leasing is more expensive than outright purchase, but remember the tax savings will generally exceed the cost of financing since leases are fully deductible from your taxable income.  With cars though you have to pro-rate it against your business vs. personal usage, so if you use your car 60% for work and 40% for other than you can deduct 60% of ALL car expenses including your lease.  So an average small/mid size car costs about $10,000 including EVERYTHING.  (lease, gas, insurance, parking, oil changes, snow tires etc.)  So over a 4 year lease that's $40,000.  If your car is 60% business usage then you can deduct $6,000 a year from your taxable income.  If your in the 25% tax bracket you just saved $1500 in taxes.  If your in the 37% bracket then it's $2200 in tax savings.  Over the course of an average lease your going to pay about $2000 to $4000 at today's finance rates for most small to medium sized cars over the course of a 4 year lease.  By leasing for 4 years, you will save $6000 to 8800 in taxes.  Which is far beyond what you'll pay in financing interest.  Plus, if you have a slower year then you can defer the deductions until you're making more money again.

If you want to truly be filthy rich then try to not expand your lifestyle as rapidly as your income increases.  Keep stashing away as much as you can afford into your investment accounts.  Open up an RRSP account if you don't already have one, and if you're hitched (or even common law) then open up a spousal RRSP as well.  If your spouse doesn't have a job in the town where you got your big break then make sure you "share" as much as you can when it comes to the finances.  Currently in Canada we don't have income splitting like they do in the USA, but rumour has it that this might be coming our way after the election and new federal budget.  However if it doesn't, then make sure you fill up your RRSP and spousal RRSP to as much as you can contribute up to your allotted contribution room.  Also, if you have any cash left over, give it to the lower income spouse and have them invest it in a CASH (taxable) brokerage account.  This way they will be "earning" money too, but it will be taxed at a way lower rate.  (Depending on what sort of investments you buy of course)

I myself haven't checked out the ramifications of "joint" brokerage accounts which are possible, but to me it just looks plain messy when it comes to income taxes, so I've avoided it.  However it's something I will investigate in the future and get back to you!

Lastly, the biggest pitfall of a sudden increase in income you start feeling down about work, or your car broke or something just sets you into a bad mood.  Try to avoid "retail therapy" if you're thinking you want something and justify the purchase by telling yourself "I'm making $X a year, I deserve it!"

Sadly if you hear yourself thinking this, stop for a minute and ask yourself if you really need it, or do you just want it, and if so can you really afford it?  (Pay off those damn credit cards first!)

Don't forget to enjoy the fruits of your labour, but make sure it's from your investment distributions!  Pretty soon you won't have to work at all if you don't want to.  It's a life/work balance that you'll have to discover on your own.  It will be hard at first but stick to the plan and I promise you'll be a rich old crank in no time at all.

1 comment:

  1. This post will prove SUPER useful in my 2011 tax year. Time to start planning ahead.