Individual investment goals may be short-term or long-term and always involve accumulating wealth. As your wealth accumulates, being a tax-savvy investor can help to increase the after-tax return on your investments.
Most of us invest our money for our retirement. In the event ones maximizes their RRSPs and TFSAs, they will look to invest outside of their registered accounts.
Tax efficient investing
Keep in mind that there are many variables to be taken into account besides tax when trying to make investment decisions. These variables include investment goals, risk tolerance, investment time-frame and anticipated income levels in retirement. Investing in marketable securities can yield
interest, dividends and capital gains. Where the investments are made in Canadian securities, each of these forms of investment return will be taxed differently.
Interest income earned from Canadian securities is not subject to special rates of taxation. It is taxed as “ordinary income” at the same rate as employment or business income. High-rate taxpayers will be taxed at the top rate of 53.53 per cent.
Most Canadian marketable securities pay “eligible dividends”. In Ontario, the combined effect of the dividend gross-up and tax credit results in a top tax rate of 39.34 per cent. For those not in the top tax bracket, the rate can be significantly lower.
Capital gains and losses
Only 50 per cent of capital gains are taxed, so the effective tax rate on capital gains in Ontario, at the top rate, is 26.77 per cent. Capital gains realized in a non-registered account can be offset by capital losses that are also realized in a non-registered account, provided the capital loss occurs no more than three years after the gain is realized.
The income earned in an RRSP will be taxed when funds are withdrawn from the RRSP, or from the related RRIF. When this income is taxed, it is taxed as ordinary income.
Investment income, including gains, earned in a TFSA is never taxed. So, any type of investment income or gains earned in a TFSA will be sheltered from Canadian tax.
Foreign investments can be an important part of a diverse investment strategy. The dividends from a U.S. public company are subject to a 15% withholding tax. If you held these in a non-registered account, the dividends would be taxed as ordinary income (not as dividends). However, you should get credit against your Canadian tax for the 15 per cent withholding tax so that the U.S. withholding tax will not generally be an additional cost to you.
Currently, there is no U.S. withholding tax on portfolio interest payments from the U.S. to Canada, so the same issue should not arise with interest-bearing marketable securities.
If you are just starting your career or getting ready to sell a business and sail off into the sunset, you want to ensure your money is working for you to meet your financial goals. Your investing strategy should be integrating income tax planning with optimizing returns and reducing risks.
Scott Conner is a partner in BDO’s Huntsvile office, with over 20 years of experience providing corporate and personal tax planning strategies for family-owned businesses, entrepreneurs, and large corporations. He helps his clients with shareholder remuneration strategies, estate planning, as well as business structuring to minimize taxes.