Taxes are a certainty. However, depending on the way in which investors structure their portfolio, they can either defer or minimize their taxes altogether. Typically, investors do not pay taxes on returns in a registered account, but must pay taxes on income and gains made in a non-registered account.
When investing in a Registered Retirement Savings Plan (RRSP), the returns accumulate tax-free until the investor makes withdrawals from the plan at retirement. The amount of tax an investor pays will depend on their total income in the year withdrawals are made.
When investing in a Tax Free Savings Account (TFSA), investors do not pay taxes on the returns that their investments generate. Unlike with an RRSP, investors do not get a tax receipt when they make a contribution to their TFSA.
All returns made in non-registered accounts are subject to tax. However, the amount of tax an investor pays will depend on the composition of the returns, that is, whether it is interest income, dividend income or capital gains – which are each subject to different tax rates.
An investor that holds a mutual fund in a non-registered account, for instance, will receive a tax slip which provides a breakdown of the components of their return for tax reporting purposes.
Any interest income earned on an investment is taxed at the marginal tax rate.
Dividend income is taxed more favorably than interest income. Investors get a federal and provincial tax credit on eligible dividend income, resulting in lower taxes.
Capital gains are taxed more favorably than both interest and dividend income. An investor will pay taxes on 50% of the capital gains that they generate in their portfolios.
To learn more, contact your financial advisor today.