This section provides a brief overview of several tax strategies and other considerations that can help you and your Investment Advisor decide where to place your investments for maximum tax efficiency:
Recognizing how gains from stocks, bonds, mutual funds and other investment income (interest, dividend and foreign) are taxed differently is key to optimizing your after-tax rate-of-return. While evaluating investments based on their after-tax return is important, you should also consider such factors as the investment’s risk, the opportunity for capital appreciation, liquidity, and so on. It is also important to note that in most cases, you will retain more after-tax income from capital gains than either Canadian-sourced dividends or interest income.
Talk to your Investment Advisor about steps you can take to maximize your after-tax investment income.
When interest rates are low, you may be attracted by the strategy of borrowing to invest, also known as leveraged investing.
Unfortunately, when deciding whether to use leverage, many people simply consider the current interest-rate environment and past market performance without evaluating their complete financial situation. Borrowing money to purchase investments is definitely not a strategy for the faint of heart. It involves significant resolve as well as various factors that should be considered and adhered to.
Discuss the benefits vs. the risks with your Investment Advisor before deciding whether borrowing to invest is right for you. Tax implications will depend on your individual situation and the type of investment you choose.
Income splitting is the reallocation of income among family members (including spouse, minor and adult child) to reduce the total amount of money paid by the family unit. A well-accepted tax-planning method, shifting income from a family member in a high tax bracket to one in a lower tax bracket can result in greater after-tax income. And although income attribution rules restrict the number of income-splitting opportunities available, there are still a number of effective ways of splitting income with family members.
Note: To ensure the desired results are achieved, income-splitting methods should be discussed with a qualified tax advisor prior to implementation.
There are two types of savings plans many investors consider when putting aside money for a child’s post-secondary education:
Although income earned in a RESP is tax deferred until withdrawn, annual contributions are limited and are not tax deductible. In contrast, income earned in an In-Trust Account is taxable each year. However, there are no limits to the amount of contributions, making it a flexible alternative.
For more information on education savings plans, please speak with your Investment Advisor.
There are numerous types of registered investment vehicles available to help you save on a tax-efficient basis: Registered Retirement Savings Plans (RRSPs), Registered Retirement Income Funds (RRIFs), Locked-in Retirement Accounts (LIRAs), Life Income Funds (LIFs), and Locked-In Retirement Income Funds (LRIFs). Of the available registered vehicles, the RRSP is by far the most utilized tax-planning tool.
For details on RRSPs, including benefits, strategies and more, please see:
A tax shelter is an investment that provides significant deductions against your other taxable income. By taking these deductions, you can reduce your total taxable income and thereby reduce the amount of tax payable to the Canada Revenue Agency.
Investors generally view the reduction in taxes payable as a tax savings, but it is more accurately viewed as a tax deferral, since ultimately either income derived from the investment or upon the sale of the investment will incur a tax liability.
Many tax shelters are considered long-term investments, and most are typically set up as either a limited partnership or as a flow-through share. Tax shelters sometimes require large investments, present a bigger degree of risk and may become subject to the Alternative Minimum Tax (AMT).
In addition, tax shelters are most appropriate for investors in the top marginal tax bracket, since the value of any tax deduction is maximized.
Consult a qualified tax advisor prior to purchasing a tax shelter to ensure it is appropriate in your situation.
Alternative Minimum Tax (AMT) is designed to target high-income individuals who have significant deductions such as write-offs from tax shelters. Items that can lead to an AMT liability include stock option deductions, limited partnerships losses and Capital Cost Allowance (CCA) claimed on tax shelter investments.
Deductible interest expense and business losses can effectively reduce your taxable income without triggering AMT. However, deductible interest expenses related to tax shelters will affect the AMT calculation.
As a result of changes to the Canadian tax system over the last several years, the tax advantages associated with Canadian investment holding companies have all but been eliminated. It is no longer possible to defer taxes through an investment holding company and, in general, the combined corporate/shareholder tax rates on investment income now exceeds the personal taxes paid on the same income.
Despite the changes in the tax system, investing through an investment holding company can still provide some benefits. For example, an investment holding company can be used to:
Split income with adult children - Assets can be transferred into the holding company on a tax-deferred basis and the adult children can subscribe for shares of the company. Dividends can then be paid to the adult children and taxed in their hands.
Freeze an estate - The primary goal of an estate freeze is to “freeze” a company’s share value for the original shareholders, while ensuring that future increases in the fair market value of the company pass to the next generation or to other desired individuals. This way, the amount of income taxes at death and probate tax can be minimized.
U.S. Estate Taxes - Another reason for using a bona fide Canadian investment holding company is to hold U.S. situs investments in order to shelter a Canadian resident shareholder from U.S. Estate Taxes. The pros and cons of this type of strategy are complex and you should seek a professional tax consultant well versed in this area.
For many Canadians, investing in the United States presents an opportunity for greater rewards and higher returns on their investments. However, it is important to understand how investments in the U.S. can affect your tax situation today and in the future.