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Managing Your Money
Taxing questions answered about interest income, dividends and capital gains
November 2005
There is no question: As a Canadian, it is virtually impossible to avoid paying taxes. And there are so many of them from GST/HST and property taxes to all sorts of taxes on your income, whether you receive it through a salary, commissions, dividends or draws from your own business, or as returns from your investments.
But, while it is virtually impossible to totally avoid taxes, it is very possible to reduce the tax bite on your income and ensure you don't pay more tax than necessary. The key is to make tax-wise income and investment decisions and that takes an understanding of the various ways in which your income is taxed. So let's begin by answering a few basic tax questions that can help you keep more of the money you earn.
Are all types of income taxed in the same way? No. The amount of tax you will pay on your basic income depends on how much you make. The Canadian tax system uses progressive tax rates meaning that your marginal rate of tax increases as your taxable income increases. Marginal tax rates, tax brackets and surtaxes vary by province, but you can expect to pay from 25 to almost 50 per cent of your income in taxes, as your income rises.
Investment income is added to your basic income and can raise the amount of income tax you pay by increasing your total income and/or pushing your marginal tax rate into a higher bracket. But, your investment dollars are taxed in different ways that can help save on taxes.
I get most of my investment income from interest is that a good tax-saving strategy? Not really. Interest income from such fixed-income investments as bonds, Guaranteed Investment Certificates (GICs) and term deposits is fully taxable at your marginal rate.
I get dividends from my stock holdings is that type of income tax-efficient? It can be. Dividend income is generally taxed more favourably than interest income. If you receive your dividends from Canadian corporations that qualify for a Dividend Tax Credit, you'll reduce your tax bite.
I sold some stocks and made a profit is that income fully taxable? Not necessarily. When you sell a capital property for more than you paid for it and that can be anything from stocks and securities like bonds and mutual funds, or real estate that you purchased as an investment you may have to pay a capital gains tax. But capital gains get the biggest tax break especially in higher tax brackets because only 50 per cent of a capital gain is included in income for tax purposes. So, if you realize a capital gain of $100, only $50 of it may be subject to tax.
Capital gains are not taxed until they are realized, so you can control when you pay taxes on your gains by deferring the sale of a capital property to a future year when your income will be lower.
Is there any way to totally avoid paying taxes on my investments? Not unless they always lose money and they produce no current income and you wouldn't want that. But there is a very good way to defer taxes from income earned on your investments and it's simple. Just open a Registered Retirement Savings Plan (RRSP). Your contributions, within limits, are fully deductible from income and all earnings in the plan accumulate on a tax-deferred basis until you withdraw them as retirement income.
But, because the government puts limits on your total RRSP contributions, you'll likely need non-registered investments to augment your retirement savings and although these will be taxed at a rate that depends on the source of income, you can design your non-registered portfolio to benefit from certain tax deferral strategies. For example, by investing in a tax-advantaged mutual fund, you can accumulate and move assets among the fund's share classes while deferring capital gains.
When it comes to tax-trimming strategies, you must be certain to follow the government's rules, and be sure the strategies are right for your overall financial plan and investment program. A financial advisor can help ensure you're taxed less and invested correctly.
This column, written and published by Investors Group Financial Services Inc., is presented as a general source of information only and is not intended as a solicitation to buy or sell investments, nor is it intended to provide professional advice including, without limitation, investment, financial, legal, accounting or tax advice. For more information on this topic or on any other investment or financial matters, please contact your Investors Group Consultant.
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