Tax-saving benefits of asset location
December 5, 2019
Asset location is a tax minimizing strategy that involves finding the most tax-effective accounts for your investments.
Unfortunately, too many investors fail to tax plan. In my experience, the number of people who pay more income tax than they have to is as high as 90 per cent. Many of those same people wish there was a way to lower their payments.
The good news is investment tax planning is amazingly easy. Here is how it works.
In Canada, we have three forms of investment income: interest, dividends, and capital gains, and they are all taxed differently.
Interest income is the least tax-efficient as it is fully taxed. One dollar of interest income is the same as $1 from employment income. You pay tax on the full dollar.
Dividend income from Canadian companies is eligible for a dividend tax credit. The net effect is you get a discount on the taxes you pay on a Canadian company dividend.
The most tax-efficient form of investment income is from capital gains. Only half of a capital gain is subject to income tax.
The starting point for you to tax plan is to make sure all your most heavily taxed, interest-paying investments, like bonds, are held within a registered account. Examples of a registered account include RRSP and RRIF. Income earned within either of these two investment accounts is not taxable. It should be noted however that they are taxed dollar for dollar upon withdrawal.
Non-registered, general investment accounts are not tax-sheltered. As mentioned, investment income from dividends and capital gains are taxed at a lower rate, so common shares are best held outside of your registered accounts. Hopefully, the stocks within these accounts will also result in capital gains which are the most tax-efficient.
Paying attention to asset location when structuring your portfolio is a simple way to reduce your income tax.
Peter Watson is registered with Aligned Capital Partners Inc. (ACPI) to provide investment advice. Investment products are provided by ACPI. ACPI is a member of the Investment Industry Regulatory Organization of Canada (IIROC). The opinions expressed are those of the author and not necessarily those of ACPI. Peter Watson provides wealth management services through Watson Investments.