Tax is top of mind in the Spring as we face the filing deadline, although it’s often too late to implement any changes that affect the previous year. The truth is, when it comes to investing, there is no tax season – it’s a year-round concern. These three tips will help you take a smart approach.
1. Understand the different ways investments are taxed. In Canada, income from different types of investments is taxed differently. Interest income, often earned from Guaranteed Investment Certificates (GICs) or bank account interest, is taxed like earned income, at your highest marginal rate. It is the least efficient from a tax perspective. Dividend income is taxed at a lower rate thanks to the Dividend Tax Credit, and income from capital gains is even more tax efficient, as only 50% of the gain is taxable. Equity-type investments such as stocks are the most likely sources of dividend and capital gains in your portfolio.
2. Take a holistic approach to tax across your portfolio. A holistic approach involves looking not just at the tax treatment of individual investments but across your portfolio as a whole. It may also be helpful to consider your financial situation beyond your investment portfolio, including real estate investments, cash savings, and your wages. For instance, if you are drawing
income from your investments as well as earning wages from work, you’ll want to make these different types of income work together in a tax-efficient way. Similarly, if you are close to retirement, you may want to begin rebalancing your portfolio to be ready to generate tax-efficient income.
3. Find the right balance between tax-advantaged accounts and non-registered investments. Canadians have access to several tax-advantaged account structures including, of course, Registered Retirement Savings Plans (RRSPs) and Tax-Free Savings Accounts (TFSAs). Each has its advantages. While contributions to an RRSP can offer an immediate tax benefit, you’ll pay tax at your full marginal rate on withdrawals. TFSAs offer no benefits on contributions, but all withdrawals – on the original investment and all profits – are tax free.
Your goals, your age, and your financial situation will determine the best strategy for tax efficiency.
Being tax savvy with your investments is a key element of building wealth over the long term and generating tax-efficient income when you need it. Professional advice is key.