Taxes are inescapable but you can still save a little by investing right! Here’s how to kill two birds with one bullet.
There are three types of investment income that you can earn:
- Interest Income – Such as from a regular savings account or bonds.
- Dividend Income – From dividend paying stocks
- Capital gains or losses – From purchasing and selling capital assets such as real estate, stocks etc.
Each source of Investment income is subject to different tax treatment. Your overall tax bill depends on how you hold each of these investments.
If you hold your investments in registered accounts, any income that you earn in that account is not taxable. The tax treatment for your contributions and withdrawals will be different for each account, though.
There are three main types of registered accounts in Canada:
- RRSP – Registered Retirement Savings Plan :This account is more suitable to save up for retirement. The contributions you make in your RRSP are tax deductible but your withdrawals from RRSP are taxable. It is more of a tax deferral program as it is expected that when you retire your marginal tax rate will be lower.
- RESP – Registered Education Savings Plan: This account is suitable to save for education of a child. The contributions in your RESP are not tax deductible and your withdrawals from this account are not taxed either. The government matches some of the contributions to an annual maximum of $500 and lifetime maximum of $7,200.
- TFSA – Tax Free Savings Account: are the exception. TFSA contributions are not deductible, and withdrawals are not taxed. Any investment income and growth is entirely tax-free.
For Non-registered accounts, the tax treatment is different:
1. Interest income:
Any interest income you earn from bonds and notes is 100% taxable at your marginal tax rate.
a.) From Foreign corporations are 100% taxed at your marginal tax rate.
b.) From Canadian corporations: To avoid double taxation, the ITA requires you to “gross up” the amount of dividend income you report by a specified percentage to bring it back to approximately what it would have been before the corporation paid tax on it. Then the tax you pay on that dividend is offset by a tax credit. So you pay lower taxes in dividend Income from Canadian corporations.
3. Capital Gains: For capital gains you are only taxed at 50% of your gain. For example if you bought a stock or property for $200K and sold it for $300k. Your net gain is $100K but you will only be taxes on 50% of it which is $50K.
And now you have better idea on how to invest and save on taxes :). If you have any questions or would like to discuss in detail on how your investments are taxed please contact us.