Most Canadians by now are well aware of the tax benefits of contributing to their registered retirement savings plans. What they might not be so aware of, however, are the strategies that can be used to save tax on non-registered accounts as well.
The first big one is the tax free savings account (TFSA).
The TFSA allows people to contribute $5,000 each year (indexed to inflation) and invest in virtually any type of investment product such as stocks, bonds, and mutual funds, like they can in their RRSPs. However, all income and gains in a TFSA are accrued and withdrawn completely tax-free.
A Harris Decima poll recently found that only about 28 per cent of eligible Canadians — those who file a tax return, are Canadian residents and are 18 or older — actually have opened a TFSA.
Part of the reason TFSAs are not being used to their fullest may be the perception that the name of the account has created in the minds of Canadians — that they are strictly a “savings” account.
“It really has been misnamed,” said Carol Bezaire, vice-president of tax and estate planning with Mackenzie Financial.
“It’s not just a savings account — it’s an investment in the future.
“It’s really a nest-egg that people can use to complement their income in retirement and it is non-taxable. People don’t understand it very well, so are not using it enough.”
Bezaire says the TFSA is a particularly good place for interest-bearing investments. Interest income is 100 per cent included in your taxable income. This means that if you earn $1,000 in interest for the year, $1,000 is added to your income and taxed at your marginal rate. If you’re marginal tax rate is 40 per cent you would pay $400 in taxes, leaving you $600 in your pocket.
In a TFSA, however, your investment income grows and can be withdrawn with no tax.
Bezaire recommends investors examine the type of income they are getting from their investments to get the best tax return on their TFSA and the best tax advantages in their non-registered accounts.
Dividends, for example, are eligible for a tax credit and are taxed at a lower rate than interest.
Eligible dividends are those issued by Canadian corporations. However, the tax credit is considered non-refundable — if you offset your taxes so much that you have a negative balance, the government will not pay you the difference. You simply would not owe any taxes for that year, although alternative minimum tax issue may result, a special levy not covered in this article.
Capital gains on increases in the value of investments, such as mutual funds or stocks, are only taxed on half of the gain. Capital gains are claimed by the end of the calendar year and can be offset by capital losses you may have.
You can plan to minimize your taxes at year end, but be aware that you usually need to do it by Dec. 24 because there is a three day settlement period and the trade must settle by year-end.
“It’s a good idea to review your portfolio and look at all your losses and gains,” said Bezaire. “It may make sense to trigger a loss in order to offset some of your gains.”
Another strategy for tax-efficient investment is to invest in corporate mutual funds. Corporate mutual funds have been around for a couple of decades but it’s only been in the last four or five years that investors have been paying more attention to them, primarily because of their tax advantages.
A corporate fund is structured as one fund that holds a number of other fund “classes” within its structure. Investors can move and transfer their money between different sectors and funds within the corporate fund on a tax-deferred basis without realizing losses or gains. Capital gains and losses only are realized when the investor transfers out of the corporate class fund.
Over time, it’s the tax deferral feature of corporate class funds that allows investors to accumulate more wealth than if they had to pay tax on their gains each time they rebalanced their portfolios. That’s because the money that would otherwise be used to pay tax can remain within the fund to compound.
Talbot Boggs is a Toronto-based business communications professional who has worked with national news organizations, magazines and corporations in the finance, retail, manufacturing and other industrial sectors. He can be contacted at email@example.com.