When it comes to growing your wealth, how much you keep after taxes is just as important as how much you earn. Tax-efficient investing helps you reduce the taxes on your investment income, allowing your wealth to grow more effectively. Below we’ll explore strategies for enhancing your after-tax returns by maximizing the use of registered accounts and adopting smart investment strategies for non-registered accounts.

Maximizing the Benefits of Registered Accounts

In Canada, RRSPs (Registered Retirement Savings Plans) and TFSAs (Tax-Free Savings Accounts) are two of the most powerful tools for tax-efficient investing.

An RRSP allows you to defer taxes by contributing pre-tax dollars. Contributions reduce your taxable income for the year, and your investments grow on a tax-deferred basis. This is especially beneficial if you're in a higher income tax bracket now and expect to be in a lower one during retirement. You'll only pay taxes when you withdraw the funds in the future.

On the other hand, while contributions to a TFSA aren’t tax-deductible, the growth within the account is tax-free, and withdrawals are completely tax-free as well. This makes the TFSA a great tool for both short and long-term savings, as you can withdraw funds without worrying about taxes on your gains or income.

Once you’ve maximized contributions to your RRSP and TFSA, there are still effective ways to reduce taxes in non-registered accounts.

Strategies for Non-Registered Accounts

Deferring or reducing tax through your choice of investments and investment strategy

Certain investments, like growth stocks or ETFs, can help defer taxes by delaying the realization of capital gains and paying taxes when it may be more advantageous for the investor. It is also common for growth stocks to not distribute income and dividends as excess cashflow is reinvested back into the growth business. 

Investors can also benefit from mutual funds and structured notes that pay a cash flow distribution that is classified as a 'return of capital'. These distributions do not come with an accompanying tax slip, and defers tax to the year that the investment vehicle is sold. 

There are also fixed income and equity strategies that make use of options and derivatives to generate higher yields. The most common are 'covered-call' and 'put-writing' strategies. The CRA considers option income as 'capital gains', which will attract less tax than interest and dividends.

Purchasing bonds at a discount and having them mature back to "par" (ie.$100) will provide a total return that is one part interest income and one part capital gain. Given the tax efficiency of capital gains, the result would be a reduced tax bill on fixed income returns. 

Tax-Loss Selling

As we approach year-end, selling investments that have lost value can help you realize capital losses to offset any capital gains. This strategy can lower your overall tax bill and allow you to carry forward unused losses to offset future gains. However, be mindful of the superficial loss rules, which prevent you from claiming the loss if you buy the same security back within 30 days.

Flow-Through Investments

Flow-through investments offer tax benefits by allowing you to claim deductions for eligible exploration expenses from companies in sectors like mining, oil, and gas. These expenses are "flowed through" to you, the investor, reducing your taxable income. By the time you sell the investment, the tax cost is usually minimal, and any proceeds would typically trigger a capital gain, with 50% taxable. Some flow-through investments may also qualify for additional federal and provincial/territorial tax credits, boosting their tax efficiency.

However, there are risks to consider. The Canada Revenue Agency (CRA) may disallow expenses that don’t meet specific criteria. Additionally, some flow-through investments require a holding period of 18-24 months, limiting your ability to sell, with the potential for investment losses if the value declines during that time.

Tax-efficient investing can be complex, and the best strategy for you will depend on your financial goals and tax situation. If you're looking to optimize your tax-efficient investment income and boost your after-tax returns, reach out to your investment advisor to create a personalized, tax-efficient portfolio.