Stop Wasting Money on Taxes! Non-Registered Investing Tips You Need to Know!
Stop Wasting Money on Taxes! Non-Registered Investing Tips You Need to Know!
How to Invest Tax-efficiently in a Non-Registered Or Taxable Account
RRSP Vs. Non-Registered Or Taxable Accounts
In the world of investments, navigating the tax landscape is crucial for maximizing returns and building wealth. While Registered Retirement Savings Plans (RRSPs) offer tax advantages for long-term savings, the story shifts when it comes to generating income from non-registered investments — otherwise known as taxable accounts. Unlike RRSPs where taxes on capital gains, dividends and income are deferred until withdrawal, non-registered accounts require a more nuanced approach to taxation.
When investors seek to extract income from taxable accounts, the challenge lies in doing so efficiently, minimizing the tax burden while maximizing returns. In this article, we delve into the strategies and considerations for achieving tax-efficient income generation from non-registered investments, shedding light on the often overlooked yet vital aspect of wealth management.
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A Refresher on Tax Rates
If you are in Canada’s top tax bracket, individuals earning $246,753 and above face significant tax rates on various types of investment income. Interest income is subject to the highest rate, which incurs a staggering 50.40% tax burden, significantly impacting returns. Though taxed at a relatively lower rate, dividends of Canadian corporations still command a substantial 37.78% tax liability for those in the highest bracket. While comparatively favourable, capital gains carry a notable 25.20% tax rate after factoring in the inclusion rate, making them an attractive yet strategically nuanced option for investors.
TIP 1: Rearrange Your Portfolio If Possible
It’s a common scenario: I see A LOT of new prospective clients often come to me with their GICs invested outside of their RRSPs, while their stocks generating dividends and capital gains are held within. The result? They’re paying the maximum tax on interest income outside of their RRSPs, when it really should be sheltered within. Optimizing the allocation of investment income is crucial for maximizing tax efficiency and boosting overall returns. A smart move involves strategically placing interest income within Registered Retirement Savings Plans (RRSPs), where it can grow tax-deferred until withdrawal, and keeping your tax-efficient investments ( stocks with capital gains and dividends in the taxable account ) thus mitigating the impact of high tax rates. On the flip side, dividends and capital gains tend to fare better outside of RRSPs, benefiting from lower tax rates in non-registered accounts. This approach not only minimizes the tax burden but also offers greater flexibility in managing finances and achieving long-term financial objectives.
TIP 2: When Investing In A Taxable Account, Look For Distributions That Are Treated As Return Of Capital
Certain income-oriented investments like income Mutual Funds, Real Estate Investment Trusts (REITs), Limited Partnerships (LPs), and Mortgage-Backed Securities (MBSs), may offer ROC distributions. These distributions can offer tax efficiency, stability in cash flow, and the flexibility to defer taxes until the investment is sold.
In Canada, mutual funds, REITs, and LPs generally operate as “flow-through structures” for tax purposes. This means that when you receive a distribution from one of these investments, it’s reported on your tax return. However, ROC distributions are generally free of immediate tax.
For instance, let’s say you invested $10,000 in an income-oriented mutual fund. Let’s say you receive a distribution totalling $1,000, of which $1,000 is classified as a return of capital (ROC). This $1,000 ROC distribution is not taxed in the year you receive it — the $1000 is yours to spend. However, it reduces the adjusted cost base (ACB) of your investment. So, if your initial investment was $10,000 and you received a $1,000 ROC distribution, your ACB would decrease to $9,000.
More on ROC Distributions
If the ROC distributions continue and your ACB goes below zero, when you finally do sell the unit, it’s considered a capital gain for that year. Any future ROC distributions are also taxed as capital gains because they exceed your original investment.
While ROC distributions might seem complex, they offer a valuable tax advantage. By receiving a portion of your investment returns as ROC, you’re essentially deferring taxes on that income until later. This means you’re not immediately taxed on the ROC portion of your distributions, allowing you to potentially defer taxes owed until you sell your investment.
This can allow you to maximize your current cash flow while retaining control over when you pay taxes. Therefore, ROC distributions can be a strategic tool for managing your tax liability over time, providing flexibility and potential tax savings in the long run.
In The End
Understanding taxes is crucial for growing wealth through investments. While RRSPs offer tax benefits for long-term savings, non-registered accounts require a different approach. To efficiently get income from taxable accounts, it’s essential to manage your investments wisely and consider options like ROC distributions. By placing certain income types in RRSPs and others outside, you can lower taxes and increase returns. ROC distributions might seem complicated, but they can delay taxes on income until later, giving you more control over your money. Mastering tax-efficient investing in non-registered accounts is vital for reaching your financial goals and securing your future.
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Joe A. Macek, FMA, CIM, DMS, FCSI
Investment Advisor, Portfolio Manager
iA Private Wealth
Toll Free North America: 1–888–324–4259
Email: macekadmin@iaprivatewealth.ca
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This information has been prepared by Joe Macek who is an Investment Advisor Portfolio Manager for iA Private Wealth Inc. and does not necessarily reflect the opinion of iA Private Wealth. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Investment Advisor Portfolio Manager can open accounts only in the provinces in which they are registered. iA Private Wealth Inc. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada. iA Private Wealth is a trademark and business name under which iA Private Wealth Inc. operates.
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