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No matter how high the returns from your investments, the real indicator of success is how much is left in your hands after taxes.
There are three main types of investment income — interest income, dividends, and capital gains. Each of these is subject to different tax treatment when held outside your registered plan. Depending on your goals, you can plan your investments to maximize your investment success. To find out more, click through the links below.
Why Invest Outside a Registered Plan?
There are many reasons for building a non-registered portfolio, from the straightforward to the more strategic.
Saving for short-term goals
Maybe you are saving for a down payment on a home, or putting money aside for a vacation. Or perhaps you want to build an emergency fund. In general, the shorter your time frame, the more secure and liquid your investments should be.
Term deposits, cashable GICs, high-interest savings accounts, and money market funds are suitable for these goals. Even though the interest you earn on these investments is taxed at your highest rate (see below), the trade-off in terms of security and accessibility can be worth the price.
To complement retirement savings
Many investors build non-registered portfolios to complement their registered Retirement Savings Plans (RSPs), especially if they've reached their RSP contribution limit for the year.
At retirement, this approach can help investors keep their retirement plans sheltered from tax for as long as possible. By drawing on non-registered savings to meet immediate income needs, you can leave your RSPs in place for as long as possible.
How Investment Income is Taxed
When considering investment opportunities, the quality of the investment and its place in your diversified portfolio should always be your main considerations. But tax treatment also plays a role.
Once you have selected the right investments suited to your goals, minimizing taxes is your next step.
Interest income
Is fully taxable at your marginal tax rate. Bank accounts, term deposits, Guaranteed Investment Certificates (GICs), bonds, and bond funds all may generate interest income.
Dividends
Received from shares of taxable Canadian corporations, and distributions from dividend mutual funds, qualify for the dividend tax credit. These investments are taxed more favourably than interest income.
Capital gains
Receive the most preferential type of tax treatment. Capital gains are taxed only when they are realized — when a capital asset that has appreciated in value is sold or transferred. Capital assets include equities, mutual fund units, bonds, real estate, and more. Only one-half of the gain is taxable. If you realize a capital gain of $1,000, only $500 will be taxable at your marginal rate.
Tip:
Generally, it makes sense to hold interest-bearing investments, such as bonds or GICs, inside your tax-sheltered registered plans, while holding investments that generate capital gains outside your RSP. |
Note: If you hold equity mutual funds outside of your registered plans, any capital gains or dividends earned by the fund will be distributed to unitholders — usually at the end of the year. This income is taxable to you.
Tax-saving Strategies to Explore
There are a number of ways to make the investment-tax rules work in your favour. Consider the following:
Have the lower-income spouse invest
Where two spouses both have earned income, the higher-income earner can pay all household bills and ongoing expenses. This frees up the earnings of the lower-income spouse for investment. The investment income generated should be taxable in the lower-income spouse's hands, at his or her lower tax rate.
Give your kids money to invest
Under the attribution rules, if you give money to your minor children to invest, any interest and dividends generated will be attributed back to you for tax purposes. Capital gains, however, will be taxable in the child's hands.
Time taxable gains
You can choose when to sell or transfer a capital asset and realize the capital gain. If you realize the gain when you're in a low-tax year, you'll pay less tax on it. Investors who take a long-term approach can defer the realization of gains for many years. You might also want to intentionally trigger a capital loss, in order to offset capital gains recognized in the same year.
Tip:
When you borrow to invest in an asset that has the potential to generate taxable income, the associated interest expense may be deductible. |
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