Managing Your Money

How to be tax efficient with your non-registered investments

Tax breaks are like Sasquatch sightings – extremely rare.  One of the very few tax breaks left to average Canadians is the Registered Retirement Savings Plan (RRSP). Your RRSP contributions are tax deductible and RRSPs allow you to build a substantial nest egg for your retirement through the magic of tax deferred compound growth. . All taxes are deferred until money is withdrawn from your RRSP  – which is usually at retirement  when your tax bracket is likely lower than during your peak earning years. 

But there are federally imposed limits on the amount of money you can invest in your RRSP, so you may not be able to achieve the later-in-life wealth level you want through investments in your RRSP alone.  That’s why a well-rounded investment portfolio should also include a mix of non-registered investments.

Trouble is, unlike RRSPs, your non-registered investments are not sheltered from taxes.  Your task then becomes selecting non-registered investments that are the most tax-efficient and capable of delivering the kind of returns you need over the long term.   These are a few investing strategies for you to consider.

The inside/outside strategy. It’s usually a good strategy to place interest-bearing investments inside registered plans and investments that enjoy a preferential tax treatment outside your RRSPs in a non-registered portfolio.  Here’s why:

·        For income tax purposes, dividends from qualifying Canadian corporations receive preferential tax treatment.  The formula is a bit complicated, but the bottom line is that a dollar of dividend income is taxed more favourably than a dollar of interest income.

·        Capital gains receive a preferential tax treatment, in that only 50% of the gains are taxable.  Even better: you control when you pay taxes on capital gains because they are not taxed until they are realized – so you can choose to sell your stocks when your marginal tax rate is lower.  You can also use realized capital losses to offset your realized capital gains – choosing when to use your realized capital losses by carrying them forward (indefinitely) or backward (for three years only) to a taxation year when your realized capital gains exceeded your capital losses.

·        Fixed income investments, such as bonds, mortgages and bond mutual funds and Guaranteed Investment Certificates (GICs), generate interest.  The entire amount of interest income from investments like these is taxed at your marginal rate -- unless you hold interest-bearing investments inside your RRSP where they can grow in a tax-deferred environment.

The capital gains deferral strategy. A very effective non-registered investment strategy for deferring capital gains taxes is the mutual fund structure known as a tax-advantaged fund.  Usually, mutual funds trigger tax consequences any time you switch from one non-registered fund to another, but funds within a tax-advantaged fund structure are treated as a single entity for tax purposes so you can move assets freely among funds within the same structure  without triggering any capital gains tax at that time.  This allows you to rebalance your portfolio or realize a gain on a fund and reinvest it in another fund within the same structure while deferring taxation on capital gains.

Tax breaks are important – but it is equally vital that your portfolio includes an appropriate balance of registered and non-registered investments within an asset mix designed to suit your financial goals, investment timeframe and tolerance for risk.  A financial advisor can work with you to develop a tax-efficient portfolio that fits your evolving needs.

This column, written and published by Investors Group Financial Services Inc., is presented as a general source of information only and is not intended as a solicitation to buy or sell investments, nor is it intended to provide professional advice including, without limitation, investment, financial, legal, accounting or tax advice. For more information on this topic or on any other investment or financial matters, please contact your Investors Group Consultant.

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