Tax planning and asset location

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Do you pay too much income tax every year? The solution could be asset location.

For individuals who have an investment portfolio that includes an RRSP or RRIF, and a regular Investment Account, this column will be of particular interest.

Consider this a practical tax planning guide. Zero math skills are required however, you may want to refer to your investment statements.

The basis for this idea is that not all tax rates are considered equal. In short, where your assets are located could mean you pay more taxes than necessary.

Employment income and interest income are taxed at your full tax rate. You are taxed at a lower rate on capital gains and Canadian dividend income.

Most investors’ portfolios will consist of stocks and bonds. Stocks have the ability to provide capital gains and dividends. Only 50 per cent of a capital gain is included in your taxable income. Eligible Canadian dividends provide an attractive dividend tax credit which lowers the taxes you pay on dividends.

From a tax perspective, stocks are good.

Interest income earned from bonds and other fixed income investments is taxed at your full tax rate.

From a tax perspective, interest income is bad.

No taxes are paid on investment earnings of any kind within an RRSP or RRIF. When funds are eventually withdrawn from either of those accounts the total amount withdrawn will be added to your taxable income.

For most, withdrawing money from an RRSP or RRIF is many years away, so there is the added advantage of delaying tax payment.

In a regular Investment Account, you are taxed on any investment income earned in the year that income is received.

For most investors it is better to hold stocks within an investment account and hold interest paying bonds in an RRSP or RRIF.

In my experience, about 90 per cent of tax payers hold stocks and bonds in the wrong account. Consequently, there is a 90 per cent chance you pay more taxes than needed.

If you fix this mistake you could save hundreds, or even thousands, of dollars every year.