POT: Portfolio Optimized for Taxes

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.

Canadian bonds

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.

Canadian equities

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:

RRSP:

  • Fixed Income: (Bonds)
  • Foreign Equities

TFSA

  • Fixed Income: (Bonds)

Non-Registered:

  • 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!

https://vixymoney.wordpress.com/

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4 Comments (+add yours?)

  1. The Dividend Ninja
    Feb 26, 2012 @ 04:51:58

    Nice post Vicky 😉 It is important for investors to remember the tax implications of their investments. While nothing is ever perfect, setting up a good plan in the beginning is key. Definitely U.S. Stocks in the RRSP and Canadian fixed income in the RRSP and TFSA. Agreed!

    I do hold Canadian stocks/equities in my RRSP & TFSA, its not the perfect place to have them, and I lose the dividend tax-credit on the dividends, but on the other hand its not taxed either.

    The TFSA is perfect for Canadian dividend stocks IMO, becuase the dividend income compounds tax-free – even though you lose the tax credit 🙂 The tax savings on that amount would be quite nominal anyway. I don’t think its right or wrong, just avoids having even more taxable income. What do you think of Canadian stocks in the TFSA?

    Cheers

    Reply

    • Vicky Vo
      Feb 26, 2012 @ 05:53:39

      I think Canadian stocks are great in TFSA! The only reason I am pulling out my Canadian equities from my RRSP is that it is the only investment that is most tax efficient in a non-registered account. I am using my RRSP and TFSA to hold my other investments. If you have sufficient room in your RRSP and TFSA, by all means utilize those first! I had a Defined Benefit pension plan provided at my previous employer so my RRSP room has definitely been restricted.

      Thanks again for dropping by Ninja!

      Reply

  2. Christine
    Feb 28, 2012 @ 03:35:26

    My interest “piqued”! Anyways, this is fascinating. No really. I haven’t read about this kind of optimization anywhere else, so thank you!!

    Also re: a post awhile ago about having a financial advisor… this article at CBC today: http://www.cbc.ca/news/business/taxseason/story/2012/02/21/f-rrsp-rate-of-return.html

    That is exactly what happened to me, where she told me “how well” I was doing. This was the beginning of the end, since it seemed obvious to me that if I was actually doing well, that I would see actual gains. It just didn’t make sense.

    So thank you, Vicky! For helping me make sense of what I need to do for myself! Lots of exclamations there for ya!

    Reply

    • Vicky Vo
      Feb 28, 2012 @ 05:36:32

      Thanks for the link; I’ll check out those calculators to see how they work.

      I’m glad you are finding things helpful! Let me know if you have any questions that you would like answered!

      Thanks for dropping by!

      Reply

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