Four simple rules for tax-wise investing

A solid return on your investments is always good thing. Paying excessive tax on those returns definitely isn’t.

You can’t totally avoid paying tax but you can reduce those taxes by making tax-wise investment decisions. Here are four simple tips:

1. Know how you are taxed. The amount of tax you pay on your investment income depends on your marginal tax rate – that’s the rate of tax you pay when you earn an additional dollar of taxable income -- and the type of investment income you receive.

   Your investment dollars are taxed in three different ways:

   • Fully taxable – that includes interest income from such fixed-income investments as bonds, Guaranteed Investment Certificates (GICs) and term deposits.
   • More favourably taxed – that includes most of the dividends you receive from Canadian corporations, which qualify for a Dividend Tax Credit.
   • Nice tax break – that’s on capital gains, especially if you’re in a higher tax bracket. Only 50 per cent of a capital gain is included in income for tax purposes.
2. Defer taxes. A Registered Retirement Savings Plan (RRSP) is the best tax-deferred savings plan for most Canadians. Your contributions (which are subject to annual limits) are fully deductible from income and all earnings in the plan accumulate on a tax-deferred basis until you withdraw them.
3. Design a tax-wise non-registered portfolio. The government puts limits on your RRSP contributions, so you may need non-registered investments to augment your savings. These will be taxed at a rate that depends on the source of the income. But even here, you can benefit from tax deferrals by:
   
   • Buying and holding investments -- taxes on capital gains are not usually paid until the gains are realized, so you can defer or even reduce taxes by choosing to sell these investments when your marginal rate is lower.
   • Investing in tax-advantaged mutual funds – this type of structure allows you to accumulate and move assets freely among the share classes of these types of mutual funds while deferring capital gains.
4. Split income to avoid taxes. Strategies that allow you to split income by having money earned by a family member in a higher tax bracket taxed in the hands of a lower-earning family member include: contributing to a spousal RRSP; making a loan to a lower-earning spouse for investment purposes; transferring assets or money to a child; or establishing a Registered Education Savings Plan (RESP) for each child. In addition, eligible pension income can now be split between spouses for taxation purposes.

Tax-wise investing should be an important part of your overall financial plan and investment program. A professional advisor can help you develop the right tax-reduction strategy for your personal situation. You may send me an email at kian.ghanei@investorsgroup.com for more information.