You work hard for your money, invest it wisely and dream of a financially secure future.  Wouldn’t you like your ‘financial-freedom’ day to come sooner rather than later?  That is the day when you’ve earned enough income during the year to pay your income taxes for the year.

One way to do that is to reduce the tax bite on your investment income.  But, to ensure you don’t pay more tax than necessary requires making tax-wise investment decisions – and that can be a complicated process.  Let’s try to remove some of that complexity with a few simple rules for tax-wise investing.

1. Understand how you are taxed.  The amount of tax you will pay on your investment income depends on two things:  your marginal tax rate – that’s the rate of tax you pay when you earn an additional dollar of taxable income; and the type of investment income you receive. 

Your investment dollars are taxed in three different ways:

·         Interest income is fully taxable.  You’ll get interest income from such fixed-income investments as bonds, Guaranteed Investment Certificates (GICs) and term deposits. 

·         Dividend income is generally taxed more favourably than interest income.  Most dividends you receive from Canadian corporations qualify for a Dividend Tax Credit that can reduce your tax bite.

·         Capital gains get the biggest tax break – especially in higher tax brackets.  Only 50 per cent of a capital gain is included in income for tax purposes.  So, if you realize a capital gain of $100, only $50 of it may be subject to tax.

2.  Take advantage of this tax-sheltered investment.  A Registered Retirement Savings Plan (RRSP) is the best tax-sheltered savings plan for most Canadians. Your contributions (within limits) are fully deductible from income and all earnings in the plan accumulate on a tax-deferred basis until you withdraw them as retirement income.

3.  Design a less-taxing non-registered portfolio.  Because the government puts limits on your total RRSP contributions, you’ll likely need non-registered investments to augment your savings, and these will be taxed at a rate that depends on the source of the income.  But even here, you can benefit from tax deferrals by:

·         Buying and holding investments -- taxes on capital gains are not usually paid until the gains are realized, so you can defer or even reduce taxes by choosing to sell these investments until your marginal rate is lower.

·         Investing in tax-advantaged mutual funds – in this type of fund you can accumulate and move assets freely among the fund’s share classes while deferring capital gains. You can even take a profit on a fund and reinvest it without immediately triggering a capital gain.

4.  Split income to avoid taxes.  There are certain strategies that allow you to split income by having money earned by a family member in a higher tax bracket taxed in the hands of a lower-earning family member.  For example, it is possible to reduce the family tax bill by contributing to a spousal RRSP, making a loan to a lower-earning spouse for investment purposes, transferring assets or money to a child, or establishing a Registered Education Savings Plan (RESP) for each child.  These strategies can effectively reduce income and capital gains taxes for a family – but only if certain rules are followed, so it’s best to discuss them with a financial or tax professional.

Nobody wants to pay more tax than necessary.  Having the right tax-trimming plan for you must be part of your overall financial plan and investment program.  A financial advisor can help ensure your tax-reduction strategy is integrated with every other aspect of your personal and financial life.