How are my investments taxed?

When it comes to investing and earning income from various investment accounts, one important question always arises: “How much will I be taxed on this?” 

The answer is always “it depends.”  

If your investments are held in your Tax-Free Savings Account (TFSA), the answer is simple: you will pay no tax (you would pay withholding tax on any dividends from a foreign investment, but that’s a subject for another article). If you hold the investments in a Registered Retirement Savings Plan (RRSP), you will not pay any annual tax on the investment. However, when you withdraw the funds from your RRSP in the future, your withdrawals will be taxed as income and you will pay tax based on your marginal tax rate at that time. In an ideal situation, you would contribute to your RRSP while you are in a higher marginal tax rate than when you withdraw the funds.

If the investments are held in a non-registered account, the amount of tax owed depends on the type of investment income that is earned. Interest, capital gains and dividends are all taxed differently, depending on your marginal tax rate.

For example, other income (like interest from bonds, GICs and high-interest savings accounts, as well as foreign dividends) would be taxed at the same rate as regular income. So, if you earned $65,000 from working and had $10,000 in other income, that investment income would be taxed at 29.65 per cent in Ontario. At that rate, you would owe $2,965 on $10,000.

However, in the same scenario, if you earned $10,000 from eligible Canadian dividends, you would pay 7.56 per cent tax, owing $756. And if you earned $10,000 in capital gains, you would pay 14.83 per cent tax, making the amount owed $1,483. As you can see, different types of investment income will result in very different tax bills.  

As your marginal tax rate increases, the benefit of the Canadian Dividend Tax Credit is reduced, and capital gains become the most tax-efficient income. If your earned income is $100,000, capital gains would be taxed at 21.7 per cent, whereas eligible Canadian dividends would be taxed at 25.38 per cent.

A key part of structuring your portfolio correctly is ensuring that the correct investments are held in the appropriate accounts. While you would never want to make an investment decision based on tax alone, if you have the ability to purchase your interest-bearing securities and foreign dividends in your RRSP, and keep investments that produce eligible Canadian dividends and capital gains in your non-registered account, your after-tax performance may be better.

This information is not intended as nor does it constitute tax or legal advice. Readers should consult their own lawyer, accountant or other professional advisor when planning to implement a strategy.

This article is supplied by Michael Dickie, a financial planner with RBC Dominion Securities Inc. Member–Canadian Investor Protection Fund. Livingston MacDonald Wealth Management helps young professionals with $200,000 or more of investment assets articulate and execute smart financial plans. Visit LivingstonMacDonaldwealthmanagement.com.