Hey, I had to peak your interest somehow.
Taxes, taxes, taxes! Everyone’s favourite time of year! In previous posts, I commented on how I wanted to hold certain types of investments in specific accounts. The reasoning behind this is how the investments are taxed, and I want to hold it in the most tax efficient place possible. This is a very broad overview as I want to try to keep it as simple as possible. I’ll even try to avoid calculations!
In general, I own Canadian bonds, Canadian equities, US equities and International equities. Based on the previous post, bonds will be subject to interest income and capital gains/losses, while my equities will be subject to dividends and capital gains/losses.
Interest income is taxed at 100% of your marginal tax rate. This is similar to how employment income (paycheques from your employer) is taxed. As a result, bonds are best held in either a RRSP account or a TFSA. Remember, in a TFSA, all the interest income and capital gains you earn will never be taxed. Consequently, you will not benefit from any capital losses either. In a RRSP, you will eventually be fully taxed when you start withdrawing the money, regardless if the money was made from interest income or capital gains.
Dividend income (from a Canadian corporation) and capital gains are taxed favourably in Canada. In other words, there are fewer taxes when the income you earn is from the previously mentioned sources. As a result, Canadian equities are best utilized in a non-registered account.
US equities and International equities
Ideally, you want any foreign investments in your portfolio to be held in your RRSP account. Even though dividends are taxed less than investment income, this only applies to dividends from Canadian corporations. Even though you will be taxed at 100% of your marginal rate when you eventually withdraw money from your RRSP, the tax deferral allows the money to compound without tax consequences until then. If you hold foreign investments in your TFSA, you will be subject to a 15% withholding tax on all dividend payouts. As these earnings are sheltered within your TFSA, you will not be able to claim this tax amount back when you are completing your annual tax return.
So a quick recap:
- Fixed Income: (Bonds)
- Foreign Equities
- Fixed Income: (Bonds)
- Canadian equities
The actual benefits from the tax savings depends on many factors, such as which province in Canada you reside in, as well as the level of income you are at. The above is the ideal allocation, in practice, it is not always easy to achieve. My portfolio is the perfect example. If you are just starting to build your portfolio, keep the above guidelines in mind.
I believe this may be advanced knowledge that may intimidate some; Level 5 in my Financial Well-being game. If this is something you are interested in and ready for, great! If the above is going to scare you and make you hesitate about investing, or even delay investing at all, I say forget about it! The best thing you can do for yourself is to start investing early (now is the next best time) and consistently and just let compounding do its magic.
I need your help! As this is a new blog, please spread the word on Facebook, Twitter, or email the link to a friend or family member. Thanks for the support!