How do I invest after topping up my TFSA, RRSP?
Q: I have fully topped up my tax-free savings account (TFSA) and registered retirement savings plan (RRSP). I’d like to know what else I can invest in to help lower taxes and maximize future investment returns? — Adriano P. Toronto
FP Answers: Hi Adriano. It’s great to hear that you have fully maximized your RRSP and TFSA. You ask a common question that I hear from clients. Depending on your personal situation, there are several strategies to consider when trying to maximize your after-tax rate of return.
If you have a spouse, you can give them money to invest in their RRSP. This assumes they have RRSP room and that their income is high enough to benefit from making contributions.
Another way to minimize your family’s tax bill on investments is to give money to your spouse or adult child to invest in a TFSA. Once children are 18, they begin to accumulate TFSA room of their own. Allowing funds to grow tax free in their TFSA may be a good way of managing your family tax bill. Just remember, their TFSA belongs to them. But they can use the funds to pay for expenses you might have otherwise paid in the future, such as post-secondary education or car payments.
If you have minor children or grandchildren, you may want to consider a Registered Education Savings Plan (RESP) to help save for their education in a tax-efficient manner. Contributions to this account are eligible for different grants and bonds from the government — most commonly the 20-per-cent Canada Education Savings Grant — but the income and gains will grow on a tax-deferred basis until withdrawn. Taxable withdrawals will be taxed at your child’s or grandchild’s marginal tax rate rather than yours if they use the funds for post-secondary education.
As you begin accumulating money in a taxable non-registered account, you could consider a loan to your spouse if they are in a lower tax bracket. You cannot just give a spouse money to invest — this results in attribution, with the resulting income and gains taxable back to you. But if you loan them money at Canada Revenue Agency’s prescribed rate of interest, currently one per cent, the income can be taxable instead to the lower-income spouse.
If you have a lot of taxable non-registered assets, you can even consider a loan to a discretionary family trust at the prescribed CRA rate. You can name multiple family members, such as your spouse, children or grandchildren as beneficiaries. The income and gains can then be allocated among them, used to pay for expenses or given to them, and taxed at their tax rate instead of yours.
Family tax planning may not apply in your situation, but there are a few other strategies to consider. The standard types of taxable income that you would receive from investing outside of a registered plan are interest, dividends and capital gains. Looking at your overall asset allocation with a focus on “asset location” may be a way to optimize your after-tax income. Certain types of income have tax attributes that are only beneficial based on what type of account they are held.
For example, Canadian dividends would be most tax efficient to earn in a non-registered account. If, say, your income is $100,000 and you live in Ontario, Canadian dividends are taxed at 25 per cent compared to 43 per cent for foreign dividends or interest income.
Growth stocks that don’t pay dividends, or exchange-traded funds with similar attributes can also generate more capital gains than dividends. Capital gains can be deferred until you sell an investment whereas dividends are payable each year. Using the same $100,000 income in Ontario, capital gains are taxed at 22 per cent and are the most tax-efficient source of investment income.
These ideas are just a few of the tactics you can use to maximize after-tax returns. Overall, many tax saving or deferral strategies are designed to benefit those who have other family members with whom they can split income. But in some cases, carefully choosing your asset location once you have determined your overall asset allocation can provide benefits over the long term.
One final recommendation is to not let the tax tail wag the dog. In other words, tax planning can help enhance your returns over time, but never forget that carefully selecting reasonable and suitable investments that are aligned with your goals should remain paramount.