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October 2018

Building a Tax-Smart Portfolio

Organize your investments to minimize tax and grow your wealth.

saving tax How your money is divided between cash, equity and fixed income – your asset allocation – is a significant driver in accumulating wealth. That said, it’s the tax-efficiency of your portfolio, including how you sort your investments between tax-sheltered and taxable accounts, that’s often the key to how much savings you’ll ultimately have to meet your goals.

Investment income: it’s not all the same

Once you invest beyond RRSPs and TFSAs and commit dollars to non-registered accounts, it’s after-tax returns which matter.

Taxation’s impact can be substantial. Say you’re in a 40% tax bracket. If you earn a 5% return, you’ll pocket just 3% net of tax – barely enough to cover inflation. If you’re in a higher bracket expect to give back even more. It could easily add up to thousands of dollars in lost wealth over time.

By understanding how interest, dividends and capital gains behave tax-wise, you can structure your holdings so you pay less.

Interest. The tax rules aren’t friendly to interest income. Whether from savings accounts, GICs or bonds, interest is taxed at your full marginal rate. If you’re a top earner in BC, you could surrender nearly 50% of your next dollar of interest income to tax.

Dividends. While interest gets a rough ride from the tax man, dividends from Canadian sources receive just the opposite.

Thanks in part to the dividend tax credit, a BC resident would pay a maximum tax rate of approximately 34% on eligible dividends, far below the threshold for interest income. Someone with no other income or deductions besides the basic personal exemption and dividend tax credit could collect up to $57,310 in eligible dividends tax-free for 2018.1

Receiving Canadian dividends leaves an investor with more after-tax income than an equivalent amount earned in interest. Foreign dividends, on the other hand, aren’t nearly as attractive. They don’t qualify for the dividend tax credit and, like interest, they’re taxable at your full marginal rate.

For Canadians there’s also the problem of withholding taxes on foreign income. Typically, 15% of dividend income from U.S. companies is withheld. The rates imposed by other countries can be higher still.

Withholding taxes can be offset by the foreign tax credit in a taxable account. And, although withholding taxes can’t normally be recovered on dividends paid into an RRSP, there’s welcome news if you hold U.S. dividend-paying companies: an exemption applies to U.S. dividends under the Canada-U.S. tax treaty. Note the same generosity doesn’t extend to a Tax-Free Savings Account. Unlike RRSPs, TFSAs aren’t considered retirement accounts for treaty purposes, so withholding tax is still a problem.

Capital gains. Anytime the market value of property you hold exceeds its cost, on paper you have a capital gain. While you must claim interest and dividend income when received, in general, a capital gain becomes taxable only when you sell the asset, giving you an opportunity to defer taxes.

Like Canadian dividends, capital gains are tax-advantaged. Only half of a gain is taxable, at your marginal rate. If you’re in the top tax bracket in BC, you would pay 24.9%. That’s half the rate charged to interest. What’s more, you can apply realized capital losses against your gains to shrink your net gain and taxes owing.

BC Tax Brackets 2018

Marginal Tax Rates (%)
Annual Taxable  Income ($)Interest & Reg. IncomeCapital GainsCanadian Dividends
   Non-EligibleEligible
Under 11,810  --  --  --  --
11,810 to 19,364 15.00 7.50 5.76 -0.03
19,365 to 20,144 20.06 10.03 9.23 -6.85
20,145 to 32,868 23.62 11.81 13.36 -1.94
32,869 to 39,676 20.06 10.03 9.23 -6.85
39,677 to 46,605 22.70 11.35 12.30 -3.20
46,606 to 79,353 28.20 14.10 18.68 4.39
79,354 to 91,107 31.00 15.50 21.93 8.25
91,108 to 93,208 32.79 16.40 24.00 10.72
93,209 to 110,630 38.29 19.15 30.38 18.31
110,631 to 144,489 40.70 20.35 33.18 21.64
144,490 to 150,000 43.70 21.85 36.65 25.78
150,001 to 205,842 45.80 22.90 39.09 28.67
205,843 and over 49.80 24.90 43.73 34.20
Combined federal and provincial marginal rates as at January 1, 2018. Assumes only credits claimed are basics personal amount and low-income tax reduction. Alternative Minimum Tax may apply.
Source: Mackenzie Investments

Finding the right place

Are stocks a better choice for a taxable account or an RRSP? Where should bonds go? Choosing the proper home for an investment will go a long way to keeping more of your profits out of government hands.

The "asset location" decision will depend on your individual circumstances and can be tricky to figure out. Here are a few general guidelines to serve as a starting point for a discussion with your advisor.

Shelter higher-taxed investments in your RRSP

Your RRSP is a solid pick for investments that either attract a high tax rate if held in a taxable account or don’t give you the opportunity to defer tax. Most fixed income investments, including bonds and term deposits, are natural choices. So are U.S. dividend-producing investments as they’re free of withholding tax. Have more in fixed income investments than your RRSP can accommodate? Turn to your TFSA as a secondary option.

Put growth-oriented vehicles in your TFSA

Non-dividend-paying stocks, domestic and foreign, that count on capital gains can be smart choices for a TFSA. Why? Any gains are tax-free. The worst place? Your RRSP. Capital gains lose their usual tax-preferred status and are treated as ordinary income when withdrawn. Nor can you use capital losses. Losing money is especially painful in an RRSP because there’s no way to restore the lost contribution room.

If you’ve already maximized your TFSA, a taxable account is normally the next best choice for growth investments because you’ll benefit from lower tax rates on capital gains.

Use taxable accounts for Canadian dividend-payers

The dividend tax credit is worthless in a registered account. That means when you’re forced to put investments in a taxable account, dividend-paying Canadian equities should usually be at the front of the line. One exception? High-yield stocks.

If the spread between your taxable dividend yield and what you’re earning on a low-rate fixed income investment in a registered account is wide enough, it may be wise for those investments to swap places to protect your rich dividend income, even if it means sacrificing the dividend tax credit.

Receiving foreign dividends from outside the U.S.? Think TFSA

Because foreign dividends don’t receive a tax break like the dividend tax credit, look to your TFSA for help, especially for dividend income from outside the U.S. Although you won’t be able to recover withholding taxes, what you save in income tax along with the opportunity to shelter capital gains will likely outweigh the costs.

Taxes and return of capital

Return of capital represents a refund to the investor of some, or all, of an original investment. If you invest in real estate investment trusts (REITs), income trusts or monthly income mutual funds, chances are return of capital is a meaningful part of your cash flow. Because return of capital isn’t taxable when paid, you benefit from tax deferral. The flip side is it lowers your adjusted cost base, possibly creating a looming capital gains tax obligation.

Receiving a steady stream of returned capital in combination with interest, dividends and capital gains can cloud your tax outlook, so see your advisor for proper guidance and take best advantage of the tax rules.

Other considerations

A singular focus on cutting taxes can make you penny wise but pound foolish in tackling your broader financial objectives. Tax efficiency needs to work hand in hand with other considerations when deciding how to allocate your investments across accounts.

Maximize your tax-sheltered investments first. If you have contribution room available in your RRSP or TFSA, concentrate on those accounts. In most cases taxes and non-registered investments should only be a consideration once you have more than enough capital to fill your tax-sheltered buckets.

Look at the bigger investment picture. When developing an investment strategy, your investment objectives, risk tolerance and asset allocation should all take precedent over tax efficiency. Do otherwise and you could wind up with investments that are a poor fit, possibly jeopardizing your savings goals.

Recognize your cash needs. From a strict tax perspective, conservative, liquid investments like savings accounts, short-term bonds and term deposits which produce interest are primary candidates for tax shelters. Yet if you’re relying on those assets to fund routine expenses or act as an emergency fund, it’s more practical to keep them close at hand in a regular account. That way you’ll avoid paperwork and withholding taxes on RRSP withdrawals, while leaving your TFSA free to shield growth investments.

Beware unintended consequences. Sometimes chasing tax savings can trigger the unexpected or lead to missed opportunities. For instance, pursuing RRSP savings too aggressively can create large mandatory withdrawals in retirement, potentially forcing you into a higher tax bracket or prompting the claw back of OAS benefits. If you have costly debt, it’s often interest expense, not tax, that’s the real enemy. Think about paying down your obligations before seriously investing.

Don’t forget about life insurance

Building wealth and saving tax. When you think of life insurance, they won’t be the first words that come to mind. But with the proper policy, you can do both. When you’re weighing investment, estate planning and risk management strategies, it’s important not to overlook the multiple benefits of a well-selected life insurance policy. Life insurance can be used in many effective ways - not only will it provide a death benefit but can also extend your ability to shelter investment earnings from tax.

Regular professional reviews can help ensure that your insurance plan and accumulation goals are keeping pace with your priorities. A BlueShore Financial Wealth Protection Specialist can provide a variety of options to best meet your needs.

Plan to pay less

Saving tax on your investments isn’t magic. What it takes is preparation.

At BlueShore Financial, our advisors will work with you to create an investment portfolio that’s tax-smart today and well-positioned for tomorrow. Speak with your advisor to learn more.



Insurance services provided through BlueShore Wealth.

1Mackenzie Investments, 2018 Tax Facts

Mutual funds and other securities are offered through Credential Securities, a division of Credential Qtrade Securities Inc.

The information contained in this article was obtained from sources believed to be reliable; however, we cannot guarantee that it is accurate or complete. This article is provided as a general source of information and should not be considered personal investment advice or a solicitation to buy or sell any mutual funds and other securities. Credential Securities is a registered mark owned by Aviso Wealth Inc.
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