How to maintain a tax-efficient portfolio
No matter how high the returns from your investments, the real indicator of success is how much is left in your hands after taxes. Taxes can have a significant impact on your overall investment returns, and their effect increases as your income rises.
One of the many benefits of having a non-registered portfolio is that it allows you to benefit from the tax advantages accorded to some investment classes.
There are three main types of investment income — interest income, dividends, and capital gains. Each of these is subject to different tax treatment when held outside your registered plan.
We can help structure your portfolio to effectively allocate your investments between your registered and non-registered portfolios, which can help to reduce the tax you pay on investment earnings.
Tax treatment of investments.
Equities and equity-based investments receive the most preferential tax treatment — only 50% of any capital gains earned are taxable.
Dividends received from shares of taxable Canadian corporations qualify for the dividend tax credit, which reduces the tax you pay on dividend income.
Interest income from investments such as bonds, Guaranteed Income Certificates (GICs), and high-interest savings accounts is fully taxable at your marginal rate.
Depending on your objectives and your holdings, it may make sense to hold interest-bearing investments inside your tax-sheltered registered plans, while holding investments that generate capital gains outside your RRSP.
A periodic review of your portfolio can help fine-tune your overall asset allocation.
Look for tax-efficient income.
Income trusts produce distributions in the form of interest, dividends, and return of capital, which is not taxable but can increase your future capital gains.
However, some distribute primarily interest income, which is fully taxable.
Choosing trusts that produce a higher level of dividends and return of capital will leave you with better after-tax gains.
Income trusts that produce predominantly interest income may be better held in your RRSP.
Fine-tune your cash flow. Holding a “ladder” of bonds with different maturities can be a good way to derive regular income from your portfolio. But while bonds have a place in every investor’s portfolio, there are other ways of producing the needed cash flow while minimizing your tax liabilities.
Distributions from high-income mutual funds, for example, may be more tax-effective than drawing income from an interest-bearing investment.
As well, you can derive income from a portfolio of mutual funds through a systematic withdrawal program, which uses the growth of the funds to provide the regular cash flow you need. Part of these returns may consist of tax advantaged capital gains.
We can ensure your overall portfolio is structured in a tax-effective manner that is tailored to your financial situation.