One of the most overlooked strategies for improving your portfolio’s return is to minimize the tax burden on your investments. By structuring your portfolio to take advantage of Canadian tax laws, your Investment Advisor may help you pay less tax, keep more of your returns and, over time, accumulate significantly more wealth. Here are some straightforward and effective ways to reduce the taxes paid on your portfolio and potentially improve your portfolio’s returns.
- Invest in an RRSP: Defer taxes on your investment income and lower your taxable income by making an annual RRSP contribution, subject to your maximum allowable room. Your 2018 Tax Assessment will tell you how much RRSP room you have for the 2019 tax year.
If you receive a tax refund, consider contributing it early to your RRSP. Or, set up a monthly plan to smooth out your contributions. Either way, your money will be tax-deferred sooner.
- Create tax deductions: If you hold investments in a non-registered account and have available RRSP room, you may want to consider transferring them directly to your RRSP or selling them to use the proceeds to contribute to your RRSP. Either way, you can create a deduction against your taxable income.
Tax rules don’t allow the triggering of a capital loss when you transfer securities to an RRSP. If you have a capital loss, consider selling first, then contribute the funds to your RRSP. You get the deduction against taxable income and you may be able to use the capital loss to offset capital gains to further reduce your taxable income.
- Don’t view a TFSA as just a savings account: Despite its name, TFSA contributions can be invested in a wide variety of investment options including stocks, mutual funds and ETFs. There are no taxes paid on the income earned for investments held in a TFSA, whether the income is dividends, interest or capital gains. TFSAs are ideal vehicles for holding investments with significant appreciation potential. However, capital losses from investments held in TFSAs cannot be used to offset capital gains in non-registered accounts.
By investing in a TFSA, you can potentially create a non-taxable income stream, which can be helpful in avoiding clawbacks in the Old Age Security (OAS) program or Guaranteed Income Supplement (GIS).
- Review asset allocation and location: Investment income can be taxed in different ways depending on the type of income and account. Fully taxable investments, like GICs, bonds, savings account and foreign stocks paying dividends, are better suited in registered accounts where the income can be tax-deferred. Investments with capital gain (or loss) potential or eligible for dividend tax credits are better held in non-registered accounts to take advantage of their preferential tax treatment.
- Harvest capital losses: The amount of capital gains subject to tax in a taxation year is based on the calculation of net capital gains (sum of all capital gains less all capital losses realized in the year). If, in a given year, capital losses are greater than taxable gains, the net loss can be carried back up to three years to reduce net capital gains previously reported to recoup paid tax, or can be carried forward indefinitely to apply against future capital gains.
Before year-end, review whether the sale of investments with accrued losses can offset gains already realized in the year. This of course depends on your investment strategy and your outlook for the security under consideration.
- Make your investment management fees tax deductible: Fee-based accounts charge an annual fee that may be used as a tax deduction. Fees on mutual funds (referred to as Management Expense Ratios – MER) or transactional accounts are not tax deductible. Furthermore, rates on fee-based account are typically lower than the MER charged on a mutual fund or transactions charged for trading. The combination of tax deductibility and lower fees can significantly add to your investment performance.
For example, a typical fee for a balanced mutual fund is 2.15% compared to 1.75% for a fee-based account following a similar strategy. For a $250,000 portfolio, a mutual fund portfolio could cost $5,365 annually compared to the annual cost of a fee-based account at $4,375.
- Take advantage of tax-efficient income: If you need regular annual income, arrange your portfolios to deliver tax-advantaged income types like Canadian Eligible dividends, capital gains and/or return of capital rather than high tax rate interest or foreign dividends. Depending on your personal situation, some or all of these “tax preferred incomes” will deliver the same cash flow but with the lowest income tax bill attached.
Managing the tax impact on an investment portfolio can have a significant and positive effect on building your wealth. Experienced Investment Advisors can identify investments designed to defer taxes and reduce the tax you pay.
Janet White, CIM®, CFP® is a Portfolio Manager with iA Securities. The opinions expressed herein are those of Ms. White alone and may not be aligned with the opinions and values of iA Securities or any of its affiliated companies. iA Securities is a trademark and business name under which Industrial Alliance Securities Inc. operates. Industrial Alliance Securities Inc. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada.