There are a number of ways to invest your money in Canada. As an investor, it’s up to you to decide where to put your money with the goal of turning a profit. While profit is great for building wealth, it is often coupled with a tax bill. Taxes, among other financial and investment management fees, eat into your profits which can be frustrating after a big win. You might be wondering, is there a way to facilitate tax efficient investing in Canada? The answer is yes!
Table of contents
- Tax on Investing in Canada
- The Most Tax Efficient Investments in Canada
- What is the most tax efficient investment in Canada?
To make the most of your money and minimize your tax bill, it’s important to understand your obligations and choose the right investment strategy for you. This guide provides an overview of taxes you can expect on your investments and how to maintain a tax efficient investing position with your portfolio.
Tax on Investing in Canada
In Canada, investment income must be classified before tax obligations can be determined. There are three main categories: capital gains tax, dividend tax, and interest/other investment income. Let’s take a closer look below.
Capital gains tax
Capital gains tax is levied on the sale of investments, such as stocks or real estate. The base for tax is calculated using the difference between the purchase price and the sale price. From there, only 50% of the capital gain is taxable. In other words, capital gains tax only arises when you sell an investment. When a sale occurs, the gain or loss becomes “realized”. If you are holding onto an investment with a gain or loss, but haven’t sold it yet, it is “unrealized”.
In Canada, there are two types of dividends: eligible and non-eligible. Eligible dividends are issued from a corporation whereas non-eligible dividends are issued from a small business. In both circumstances dividend income is “grossed up” and recognized as taxable income. From there, the taxpayer is eligible for the dividend tax credit. Generally speaking, dividends are taxed favourably compared to other types of investment income.
Related Reading: Best Monthly Dividend Stocks in Canada for 2022
Interest and other investment income
Interest income is taxable as regular income. Other investment income, such as foreign interest and miscellaneous investment income, fall under this umbrella too. In essence, other investment income is a catchall for income earned while investing that doesn’t fit anywhere else. Both interest and other investment income are subject to tax at your marginal rate.
The Most Tax Efficient Investments in Canada
Exercising a tax efficient investing strategy is tax planning, in essence. Each type of investment has its own benefits and drawbacks from a tax standpoint, plus a whole other set of pros and cons as a standalone investment. If you want to minimize taxes, you must absorb the full picture of the investment before purchasing, including future tax implications, which can take time.
Let’s start by looking at the tax-sheltered accounts available to Canadians. These accounts have lucrative tax advantages that will help you remain tax efficient. From there, we’ll take a look at tax efficient investing strategies.
A Tax-Free Savings Account (TFSA) is a great way to grow your savings while enjoying tax-free earnings. Here’s a brief overview of how they work.
TFSAs were introduced in 2009 and are available to Canadian residents who are 18 years of age or older. You can contribute up to a specified contribution limit each year, and any investment growth within the account is tax-free. That means you don’t have to pay income tax on any interest, dividends, or capital gains earned within a TFSA. If you withdraw money from your TFSA, you can put it back at any time without affecting your total contribution limit.
With a TFSA, you’re in control of your own finances and you can choose how to invest your money. Whether you’re saving for a down payment on a home, investing for education costs, or simply trying to grow your wealth, you can benefit from a TFSA. This is especially true if you’re concerned with tax efficient investing in Canada!
Read More: Tax-Free Savings Accounts (TFSAs) in Canada
A Registered Retirement Savings Plan (RRSP) is a special type of savings plan that offers tax benefits to encourage Canadians to save for their retirement. Contributions to an RRSP are deducted from your income. Plus, any earnings on your investments do not face taxation. The only time monies are taxed is when you make a RRSP withdrawal. However, it is taxed as regular income, not as investment income. With an RRSP, you can control your tax bracket by manipulating withdrawals.
There are two main types of RRSPs: individual and spousal. An individual RRSP is registered in your name only. Whereas a spousal RRSP is registered in the name of your spouse or common-law partner. Married couples or common-law partners can essentially share their RRSPs as a way of income splitting. If you have a pension plan at work, you may also have the option to contribute to a group RRSP.
RRSPs are helpful tools for Canadians, from both a tax and retirement savings stance. While there isn’t as much flex with a RRSP as a TFSA, you should still consider opening a RRSP for tax efficient investing purposes.
Read More: The RRSP in Canada
TFSAs and RRSPs are the most commonly used registered accounts because virtually any Canadian can open one in their lifetime. However, there are other registered accounts available too, with more specific uses. They are:
- Registered Education Savings Plan (RESP). A special account that allows Canadian parents to save for their children’s post-secondary education.
- Registered Disability Savings Plan (RDSP). An account that helps Canadians with disabilities invest and cover costs related to their condition.
- Registered Retirement Income Fund (RRIF). Once you reach retirement age in Canada, you can convert your RRSP into a RRIF to receive recurring income while retired.
All of these accounts have tax benefits similar to a TFSA or RRSP. If you meet the specific criteria to hold one of these accounts, definitely consider opening one to facilitate your tax efficient investing goals.
Strategies to be tax efficient with your entire portfolio
Above, we explored the various kinds of registered accounts and how they can contribute to tax efficient investing in Canada. You can also have a non-registered account for your investments – but full investment tax will be in effect! However, in some cases, it’s more ideal to keep your investments in a non-registered account, as you will see below.
Now for the question of all questions, how to make your investments tax efficient in Canada? To be honest, there are a ton of moving parts! It can be challenging to come up with a one-size-fits-all solution. Below are some proven strategies, but you may have to come up with your own solutions based on your specific circumstances.
Keep Canadian dividend stocks out of registered accounts
As mentioned above, dividends are taxed favourably in Canada. Although, this is only true when it’s a Canadian dividend stock. Foreign dividend stocks will likely be considered foreign investments which are not taxed as favourably. For this reason, it’s ideal to keep Canadian dividend stocks in non-registered accounts.
Related Reading: How to Withdraw Money from TFSA
Keep stocks with high growth potential in registered accounts
Stocks with high growth potential will eventually face a hefty capital gains tax when you sell them. This is because the value of your investment has the potential to grow immensely, thereby creating a larger gain. For this reason, it’s best to keep these investments inside registered accounts to avoid capital gains tax.
Keep international investments in registered accounts
Foreign investments are taxed more harshly compared to their Canadian counterparts. This is because the government wants to motivate Canadians to keep their money in Canada, as opposed to in international markets. In addition, the CRA considers it a luxury to be able to invest abroad as the average Canadian may not have the means to. For this reason, it’s best to keep international investments inside registered accounts.
Keep bonds and interest producing investments in registered accounts
Investments that yield interest trigger a tax burden every single year. Since interest is included with your taxable income, it’s best to keep this number as low as possible. To maintain a tax efficient investing position, keep interest producing investments in registered accounts.
Keep REITs in registered accounts
REITs are known to produce a high level of investment income, typically in the form of dividends. This is because the holders of the trust must allow the majority of their rental income to flow through to shareholders. It is best to keep REITs in registered accounts for this reason.
Related Reading: TFSA vs. RRSP: Where to Put Your Money
Aim for eligible dividends (not non-eligible)
Eligible dividends are taxed more favourably than non-eligible dividends. Eligible dividends are paid to a resident of Canada from a Canadian corporation. The tax difference is slight, but this is a detail to consider for tax efficient investing in Canada!
Use capital losses where possible
Capital losses can only be applied against capital gains for tax purposes. For this reason, you should optimize your capital losses in years where you have realized a capital gain. This process is known as tax loss harvesting. It is the process of selling investments that have lost money so you can use the loss to offset any capital gains you may have realized during the year. Tax loss harvesting can lower your tax bill in years where you have capital gains.
What is the most tax efficient investment in Canada?
There is no such thing as the most tax-efficient investment. This is because there’s no one-size-fits-all solution when it comes to tax efficient investing in Canada. It’s more about balancing your portfolio to minimize tax where possible. This can be done by ensuring you have a mix of different types of investments, including both registered and non-registered accounts, as well as different types of investments within each account. In addition, by understanding Canadian investment income tax, you can make more informed decisions with respect to your portfolio. From there, you can find the most tax efficient investment for you!