My financial chronicle
How is my investment income taxed?
All investments are not created equal. What's more, the returns they generate are taxed based on the type of income they produce: interest, capital gains, or dividends.
If your investments are in an RRSP or an RRIF, your taxes won't be affected. Why? Because in these tax shelters, no investment income is taxable while it remains in the plan, and, once redeemed, all returns are taxable in the same manner-as interest income.
However, if your investments are not tax exempt (not registered)–also known as “outside your RRSP”–the returns they generate will be taxable each year. But taxable how?
If your non-registered investments generate interest income, this income will be taxable at your marginal rate. This rate is the percentage of taxes-federal and provincial combined-that you pay on the highest taxed portion of your taxable income. All guaranteed investments-GICs or fixed term deposits, savings bonds, and Treasury bills-generate interest only.
On the other side of the spectrum, if your non-registered investments generate capital gains, only 50% of these gains will be taxable. This means that capital gains will cost you 50% of your marginal rate in taxes. Capital gains are loosely defined as the difference between the price paid for a security, e.g., a listed stock, and its resale price, net of fees. Stock in private or publicly held companies, marketable bonds, immovables, or mutual funds that invest in the foregoing generate capital gains... or sometimes capital losses!
Between the two, there are dividends. We say between the two because dividends are taxed at between 66% and 75% of your marginal rate, depending on your income. Dividends enjoy special tax treatment because they are remitted by companies with money that has already been taxed. This avoids double taxation. Preferred stocks and ordinary stocks in Canada's largest corporations as well as the mutual funds that invest in such stocks generate this type of income.
What's the moral of the story? If you have some registered investments and others that are not registered, it's better to hold those that generate interest in RRSPs, where they will cost the least in taxes. As for investments that generate capital gains and dividends, the best thing to do is hold them in the non-registered portfolio. That said, you should still keep in mind the objectives and horizon of each investment before making such a decision; the impact on your taxes should only be taken into account as a last consideration.
Do you need a professional opinion on your personal situation? Consult with your financial advisor at La Capitale for answers that will simplify your finances.