Tax Efficiency

You could potentially retain thousands of dollars by incorporating tax efficiency into your investment strategy. A solid understanding of how profits from investments are taxed, which investments to register or not register, and tax efficiency strategies is the first step.

Taxes on Investment Income

Capital Gains

You will pay the least amount of tax on income from capital gains – your marginal rate on only 50% of your profit. In addition, any losses can be written off against profits and profits can be deferred as you only pay taxes when you realize your gains.

Interest

You will pay the most taxes on interest income, your full marginal tax rate on 100% of income.

Dividends

Dividends from Canadian Corporations fall somewhere between capital gains and interest when paying taxes. Taxes on profits are paid out by corporations, prior to distribution to investors, who can be eligible for an enhanced dividend tax credit. In addition dividends can be received with no federal tax payable up to a specific limit if you have no other source of income.

Registered VS Unregistered investments

Investments providing interest income are best kept within a registered account so taxes can be deferred until a time when your marginal tax rate is lower. Investments that produce capital gains are best kept out of a registered plan, as you will be taxed on 100% when withdrawn and in the case of losses, you won't be able to claim them. Dividends from Canadian companies should also be kept out of registered accounts in order to take advantage of the tax credits.

Registered Retirement Savings Plans

A RRSP is a tax deferral tool for employed Canadians who anticipate being in a lower marginal tax bracket when they retire. Investment income is allowed to grow and compound tax-free. Yearly contributions can be deducted from income resulting in a tax return equal to your contributions times your marginal tax rate. (e.g. a $6000 contribution with a marginal tax rate of 38% would provide a tax return of $2280 ($6000 x 38%)  Tax is paid when the money is withdrawn based on the marginal tax rate for the year is it withdrawn

Independent Pension Plans (IPPs)

An IPP is a registered pension plan which can be set up for small business owners, entrepreneurs and eligible executives who are over 40 with annual incomes over $100,000. The contribution limit is based on age, length of service and income and is typically higher than a typical RRSP.

Tax Free Savings Account (TFSA)

As of January 1, 2009 Canadians are able to earn investment income tax free through contributions to a TFSA account. Contribution amounts are not based on income and all Canadians over the age of 18 for the year of 2015 may contribute up to $10,000. Limits will change in future years and any unused contribution room can be carried forward from year to year. Contributions are not taxable and may be invested in stocks, bonds, GIC's or mutual funds within the TFSA.
Money within the TFSA can be withdrawn at any time for any reason and are not included in your income nor will you be taxed on the withdrawals. The money may be re-contributed in subsequent years without penalty. Contributions to a TFSA will not affect your RRSP limits.

Registered Education Savings Plan (RESP)

An RESP allows you to save and invest money tax deferred to be used for your children or grandchildren's post secondary education. Yearly contribution limits are $2,500 and there is a government grant available based on your income. You can set up an individual plan or a family plan.

There are two types of RESP's, the first can be purchased through a financial institution or mutual fund company and the second is through a Scholarship Trust company. All plans work a little differently; some are more strict than others. When it come to the investment portion, you can choose a managed or self directed plan and investment options include savings accounts, GIC's, bonds, mutual funds, stocks and bonds.

It is important to understand the rules, options and risks of the different plans and how they may affect you. There is a risk the investments won't perform as expected; your beneficiaries may choose not to further their education after high school; and your investment costs may reduce your returns. As these risks can vary between plans, choosing the right plan can reduce some of those risks and ensure the money is there when your children need it.

Visit our Investing and Savings page for more information on the many services Bircher Financial offers to help clients achieve their goals and dreams.