Spotlight on investment tax rates
I’m paying how much??
HAVING A HIGH-PERFORMING INVESTMENT PORTFOLIO that generates big returns is exciting stuff. But do you know how your investment earnings are taxed? Just as you would assess your level of comfort with risk, it’s a good idea to have a solid understanding of the tax rates on various investments if you hold them in a non-registered (taxable) account. From capital gains to interest and dividends, consider this your tax primer on investments.
Different types of investment income
A great place to start is to know your marginal tax rate, which is based on the combined federal and provincial tax brackets. Search "2019 Tax Rate Card" at https://repsourcepublic.manulife.com. Next, you will want to understand the different types of investment income available to you, which may include interest earned on savings accounts, dividends paid by stocks, foreign investment income, or capital gains and losses that can occur when you sell an investment.
Canadian interest income
Taking the biggest tax hit is the interest earned on Canadian savings accounts as well as the interest earned on Canadian fixed-income investments – think government bonds, bank or insurance-based guaranteed interest contracts (GICs) and government treasury bills (T-bills). Interest income can form part of the allocations or distributions received from segregated fund contracts or mutual funds, respectively. This interest is taxed at your marginal tax rate which is the rate of tax charged on your last dollar of income earned.
There are no special tax breaks on foreign income, whether it’s in the form of interest earned or dividends, making this investment vehicle on par with the high tax rates paid on Canadian interest noted above, but with a twist. On foreign dividends, some tax is withheld before the dividend is paid to the investor. The tax withheld goes to the government of the company’s country of residence. Not to worry – this tax creates a credit that can reduce your Canadian tax owing, eliminating double taxation in most cases.
Dividends are the money paid by corporations to shareholders from after-tax earnings. Compared to interest income, Canadian dividend income gets preferential tax treatment thanks to the gross-up and tax credit system currently in place. Speak to your advisor to better understand how gross-up and tax credits apply to dividend earnings.
Capital gains and losses
Capital gains come with the ownership of capital property, which can be investments like real estate or shares in a company. Imagine that you purchased shares in a hot tech company for $10,000, and then a year later you sold those shares for $15,000. The $5,000 increase is called a capital gain. The good news is that only 50 per cent of this growth is included in your taxable income. So, you would only be taxed on $2,500 rather than the full $5,000. The tax liability for capital gains can be reduced or eliminated in a couple of ways:
- Offsetting capital gains with capital losses from other investments
- Donating securities to a registered charity or private foundation. Capital gains related to donating eligible securities are not included as taxable income.
To recap, interest and foreign income is taxed annually at an investor’s marginal tax rate, Canadian dividends are taxed at lower rates, and capital gains are taxed only when realized, typically when an asset is sold.
Putting it all together
Understanding how taxes apply to common investment vehicles is also important. Such assets may include mutual funds, exchange-traded funds (ETFs) and segregated fund contracts. When the investor sells any of these asset types, the result may be a capital gain or loss.
Starting with mutual funds, any distributions an investor receives while holding a mutual fund will be taxed differently depending whether the fund is structured as a trust or a corporation. In the case of a mutual fund trust, distributions are taxed according to the nature of the distribution, which can be a capital gain, dividend, interest or foreign income. Mutual funds structured as corporations pay either Canadian dividends or capital gains dividends.
ETFs are traded like a stock and can invest in a wide range of securities that can generate different investment income. Like mutual fund trusts, distributions can include interest, foreign income, Canadian dividends and capital gains. Such income is taxed accordingly.
If you are invested in segregated fund contracts, then the allocations you receive are taxed according to the allocation (dividend, interest, capital gain, etc.).
As always, when it comes to your investments, consider your financial goals, the amount of time you will invest and your tolerance for risk. Feel confused or overwhelmed? Your advisor can help you make sense of the best tax strategy for your investments.
TFSAs AND RRSPs
Other important investment vehicles that offer tax advantages include Registered Retirement Savings Accounts (RRSPs) and Tax-Free Savings Accounts (TFSAs).
RRSP contributions are tax deductible, the income earned within your RRSP is not taxed until you begin to withdraw the funds at retirement, when you are likely in a lower tax bracket. Also, you can contribute to a spousal RRSP to income split if you expect your spouse to be in a lower tax bracket when withdrawing the funds and save even more tax.
A TFSA is a great way to invest money tax-free with the flexibility to tap into your savings without penalty at any time. Every Canadian over the age of 18 is eligible to contribute up to the maximum annual amount, plus any unused amount from previous years. The maximum annual contribution for 2019 is $6,000.
© 2019 Manulife. The persons and situations depicted are fictional and their resemblance to anyone living or dead is purely coincidental. This media is for information purposes only and is not intended to provide specific financial, tax, legal, accounting or other advice and should not be relied upon in that regard. Many of the issues discussed will vary by province. Individuals should seek the advice of professionals to ensure that any action taken with respect to this information is appropriate to their specific situation. E & O E. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Any amount that is allocated to a segregated fund is invested at the risk of the contractholder and may increase or decrease in value.