Canada has a graduated or progressive tax system whereby, the more money you make the more you pay in taxes. This is why Canadian investors and high-net-worth individuals have to be extremely careful in terms of how they invest and what they invest in. The tax repercussions of their investment decisions can easily result in them paying out most of their gains in taxes with little to no financial reward.
In this guide, we will learn about the different types of taxes that apply to different types of investments, what tax-efficient investment strategies can be used to minimize the impact of taxes on returns, and other tips and tricks for tax planning for Canadian investors.
How Can Tax Impact Investment Returns?
The first thing that any Canadian investor should understand is that the Canada Revenue Agency (CRA) does not tax all income the same way. Your income from your job or business is taxed a lot differently than the income generated from your investments.
So, what is considered investment income? Well, the three most common types of investment income include capital gains, dividends, and interest. Each type is also taxed differently.
For example, any income generated from interest made on investments in savings accounts or Guaranteed Investment Certificates (GICs) is taxed at the same marginal tax rate as an individual’s income tax. This makes these investments unfavourable for tax efficiency even though they are considered low-risk investments.
In contrast, investment income generated from dividends is given preferential tax treatment, which means you get to keep a lot more of what you make!
Any income generated from the sale of an asset/investment is considered a capital gain. Capital gains are also considered tax-efficient investments as only 50% of the income generated is subject to tax. Long-term capital investments are also taxed at a preferred rate rather than your marginal rate which leads to further tax savings.
A tax-efficient investment portfolio should ideally consist of a mixture of about 70% equity investments and 30% interest-bearing investments. Those seeking a highly tax-efficient investment portfolio should only consider investing in equities. This is because the income generated from equity investments (dividends and capital gains) is taxed a lot more favourably than any form of interest-bearing investment.
These are but some of the ways taxes can impact your overall investment returns. Having an investment portfolio designed to be tax efficient can help you save a lot more of your hard-earned income. This is because tax-efficient investment portfolios focus on maximizing returns post-tax, rather than on the total value of income generated pre-tax.
Using Tax-Efficient Investment Strategies To Reduce The Costs Of Taxes On Your Investment Portfolio
RRSP contributions, for example, can be deducted from your pre-tax income, which can ideally help bring you down to a lower tax bracket/marginal tax rate. RRSPs also allow for spousal income splitting which can be hugely advantageous if one partner makes much more than the other. The combined income of the two can bring down the marginal tax rate significantly and is an excellent tax planning strategy for all married couples.
TFSAs are also advantageous as even though the money you invest into them is ‘after-tax income’ when you withdraw the funds you can do so without having to pay any taxes. Any gains you make on those investments are also tax-exempt.
Both RRSPs and TFSAs can also be used to invest in financial products such as Mutual Funds, GICs, ETFs, stocks and more which can help further diversify your investment portfolio as well as provide tax benefits.
Apart from saving in registered accounts, which in many cases you should be doing, there are plenty of other tax-efficient strategies that can help reduce the impact of taxes on your investment returns. This includes investing in equities and other capital investments.
However, just because some investments seem to be more tax efficient than others doesn’t mean you should invest in them. As we mentioned earlier, not all income is taxed the same. Even though an investment may have perceived tax benefits, those benefits may not pertain to your current financial situation, risk tolerance levels, or investment goals.
It is recommended to consult with a financial advisor or wealth management expert to get the best advice on how to lower the impact of taxes on your investments to get the most value from your returns.
Tax Planning Tips For Canadian Investors
While investment strategies and tax strategies can vary from person to person, some tips and strategies are beneficial to most. So, here are some of our top tax planning tips for Canadian Investors.
- • Always make the most of any tax credits or deductions that apply to you.
- • Invest in RRSPs, TFSAs, and ETFs.
- • Make use of pension or income-splitting strategies with your spouse.
- • To get a quick and easy estimate of your total applicable tax use an online tax calculator.
- • Build a diversified portfolio with the right mixture of cash, fixed income, and equity investments that suit your risk tolerance levels and are in line with your retirement or investment goals.
Consult With Expert Financial Advisors To Help Optimize Your Investment Portfolio For Tax Efficiency!
Building the right investment portfolio that offers great returns while also being tax efficient is no easy task. This is why it is best to consult with experts that do this daily!
At Eastport Financial Inc., our Canadian Tax Planning professionals are dedicated to preserving the wealth and assets of Canadian families and have helped so many clients achieve and in some cases surpass their life, investment, and retirement goals.
To learn more or book an appointment give us a call at 902-474-5433. One of our representatives will be happy to help!