Tax-efficient strategies to help maximize returns
1. Investors with RRSPs and TFSAs may think they don’t need to worry about the tax implications of their investments, but that isn’t true: Foreign dividends earned in a TFSA are subject to withholding tax by the source country and Canadian mutual funds or Canadian-listed exchange-traded funds that own foreign stocks are also subject to withholding tax on dividends earned in an RRSP.
RRSP withdrawals will be taxable someday, so how big to grow an RRSP and when to take with- drawals is another tax consideration for registered accounts.
U.S. stocks trading on a U.S. stock exchange are not subject to withholding tax when held in an RRSP — but they are in a TFSA. So RRSPs may be a better option than TFSAs for U.S. stocks. But where you hold non-U.S. foreign stocks depends on overall asset allocation and whether you have non-registered investments.
2. Those with non-registered investments should consider leaning more toward earning capital gains or Canadian dividend income. Capital gains are only 50-per-cent taxable in a non-registered account. Canadian dividends are taxed at a lower rate than interest or foreign dividends, but the rate depends on your tax bracket.
3. Real estate investment trusts (REITs) and limited partnerships (LPs) generally pay out distributions to investors in different forms. While some income may be considered taxable dividend income, some portion may also be considered return of capital. Tax is not immediately payable on return of capital, but will reduce your cost base on an investment and increase the taxable capital gain when you ultimately sell it. REITs and LPs can boost aftertax returns in a taxable account.
4. Universal life insurance has a savings feature that can be allocated into active and passive investment options that grow tax-free. Fees tend to be higher than non-insurance solutions, so fees and tax savings must be compared. Whole life insurance invests some premiums on a tax-free basis into unique asset classes. Commissions are generally high up front, so a whole life policy should not be a short-term commitment.
5. Rental real estate can be very tax-efficient. Mortgage interest is tax deductible and a financed rental property can sometimes create tax refunds. Even cashflow-positive properties can have income sheltered from tax by claiming depreciation.
6. Flow-through shares can earn tax-effective returns and create refunds more than 50 per cent of your investment. The government incentivizes investors to buy flow-through shares issued by junior resource companies. These shares are risky, so tax refunds are used to attract investors.
In summary, there are many different tax-efficient ways to invest, but keep in mind that tax should never be the primary decision-making factor.
A thorough understanding of retirement and estate objectives should be a starting point for any investment plan. From there, seek out tax-efficient returns.
There are many different tax-efficient ways to invest, but … tax should never be the primary decision-making factor.