Strategies for tax-efficient investing

Keeping what you’ve earned

While your investments won’t escape the tax net, the right planning can help you keep more of your returns. Not all investmentᶲ income is taxed in the same way, so it makes sense to evaluate what's in your portfolio in light of its tax exposure.

There are three basic types of income you can earn from an investment: interest, capital gains, and dividends. While interest income is fully taxed at your marginal rate, dividends from eligible sources, such as shares in Canadian public companies or mutual fundsᶲ, benefit from the Dividend Tax Credit. In Canada, capital gains are subject to tax, with federal government changes made to the structuring of those taxes in 2024. Annual capital gains up to $250,000 are taxed at 50% of the value, and for any capital gains over $250,000, the rate increases to 66.67%. It is wise to discuss this matter with a tax or accounting specialist so that you are prepared with a strategy that suits your needs.

Reorganize, restructure, reduce

If you're holding both registered and non-registered investments, how you structure your portfolio counts when it comes to reducing your tax burden. Because interest income attracts the highest marginal tax rates, interest-generating investments like GICs and savings accounts should be placed in an RRSP or TFSA.

You can then take advantage of the tax benefits of dividends and capital gains by leaving your equity holdings in a non-registered accounts. Sheltering your highest taxed investments will help reduce your overall tax bill.

Here are four basic tax-saving strategies:

1. Tax-sheltered – protect your gains

• RRSP: Aside from the immediate tax deduction, investments held in your RRSP grow tax-deferred. How much will it matter? If you're in a 40% tax bracket, $50,000 in term deposits paying 3% annually will grow tax-sheltered to just over $90,000 after 20 years in an RRSP, earning about $19,000 in tax savings compared to a similar non-registered investment. Another benefit is that when you withdraw the money as income in retirement, you'll likely be in a lower tax bracket than during working or earning years.
• TFSA: When you put the annual maximum into a TFSA, you pay no taxes on the interest earned within the plan. Because there are no tax consequences to withdrawing funds (unlike RRSPs), the TFSA is an ideal way to save for short-term needs. If you're already maximizing your RRSP contributions, adding a TFSA is an effective way to shelter more of your income from taxation.
• RESP: If you're saving for your children's education, investments can grow tax-sheltered in an RESP. By starting an RESP before your child turns seven, the Province of British Columbia will put $1,200 into the child's RESP. The BCTESP grant requires no matching or additional contributions. You can also receive up to an additional $500 annually through the Canada Education Savings Grant to a maximum of $7,200 for the life of the RESP. When withdrawn, the income is taxed based on the child’s income – usually at a much lower rate.

2. Tax-preferred – reduce the tax

Dividend investments like stocksᶲ offer a tax advantage over other investments such as bondsᶲ and term deposits. When held outside a registered plan, eligible dividends – generally those from Canadian public companies – can benefit from the Dividend Tax Credit.

If you're in one of BC's higher tax brackets, you could pay 30% to 40% more tax on interest income than you would on dividend income. Spread that tax reduction over even a part of your investment portfolio and the savings can add up. 

Eligible investments with the potential for capital gains can also complement your strategy; as of June 2024, if your gain is under $250,000 it will be taxed at 50%, and above that amount, the tax rate jumps to 66.67%.

3. Tax-deductible – borrow to invest

When you borrow to make an investment, the interest you pay on that loan may be tax-deductible; consult with your financial advisor and accountant to see how this might work in your unique circumstances.

Flipped on its head, paying down non-deductible debt first – things like credit card balances – is an investment in itself given how high those interest rates are. For example, if you're in a 40% tax bracket, you would need to earn the equivalent of 30% on a guaranteed investment to enjoy the same after-tax benefit as paying down a credit card balance at 20% interest.

4. Tax-splitting – share the load

If you have family members in various tax brackets, there are some simple ways to pay less on your combined investment income. If your spouse earns less than you, consider making a contribution to a spousal RRSP. You get the tax deduction and at retirement, having two similar-sized RRSPs will save tax over a single larger plan.

Use your spouse’s disposable income for investing and use your income for expenses. Because they're in a lower tax bracket, a dollar of investment income earned in their hands will trigger lower tax consequences.

If your children are old enough to earn a part-time income, provide their spending money and let them invest their income. They're likely to pay little or no tax. If you give funds to your minor children to invest, choosing options that produce capital gains is tax-smart. Unlike interest income or dividends, any capital gains are not attributable back to you.

For any of these strategies, the best way to get started is to have a conversation with your BlueShore financial advisor. They can recommend which steps will work best for your financial situation.