Outside of registered accounts, tax efficiency plays a key role in building wealth.

 

Most Canadians take advantage of tax sheltering within a Registered Retirement Savings Plan ( RRSP ) or through the tax-free benefits of a Tax Free Savings Account ( TFSA ). However, outside of registered accounts, tax efficiency plays a key role in building wealth.

 

Not all income is taxed the same

 

Income from your investments can come in various forms, the most common of which include interest, dividends and capital gains.

 

These income types are tax differently by the Canada Revenue Agency. For example, like wages, interest income typically earned on such investments as Guaranteed Investment Certificates (GICs) or savings deposit accounts is taxed at an individual’s highest marginal tax rate, making it the least efficient form of investment income. By contrast, dividends paid on stocks issued by eligible Canadian corporations receive more favourable tax treatment, since this type of income benefits from the federal dividend tax credit. In other words, dividend income is more tax-efficient than interest income, which ultimately means that investors in dividend-paying investments keep more of what they earn after taxes.

 

Capital gains materialize when you sell your investment for a higher price than what you paid for it. This difference is recognized as taxable income. Similar to dividend income, capital gains also receive relatively favourable tax treatment, since only half of the capital gain is subject to taxation. Dividends and capital gains are typically earned on equity investments.

 

Tax efficiency in investment portfolios

 

If your investment plan includes long-term goals, like a comfortable retirement, minimizing the amount of taxes you pay on your investments can have a tremendous impact on your portfolio over time. That is why building an effectively diversified portfolio — one that includes the appropriate mix of cash, fixed income and equities according to your investment objectives — is key to building wealth and accelerating growth over time.