How do you invest for tax efficiency in your Canadian non-registered account?
This is a very important question for your retirement strategy. Sure you want to be efficient while you grow your portfolio but it becomes critical when you start withdrawing from the accounts.
What it comes down to is to have a clear understanding of the diffence taxes that can impact you. Below are the type of distribution you can receive from stocks, bonds, ETFs, and mutual funds. Learn about the taxes applied to each.
Here is what an example of an ETF in a non-registered account pays you from the fund. I bougth BMO ZWU Covered Call ETF in my corporate account for example.
Source: BMO ZWU ETF
In a TFSA or RRSP, we don’t tend to think much about taxes but once you start building your non-registered account, it’s very important to understand taxes.
Non-Registered Account Tax Rates
Here is a simple example for someone earning $50,000 across various tax rates. The income assumes you only generates $50,000 from one of the income type.
In a number of provinces you can earn $50K in dividends tax-free!
| $50,000 Ordinary Income |
$50,000 Capital Gains |
$50,000 Eligible Dividends |
|
| AB | 25.00% | 12.50% | 2.57% |
| BC | 22.70% | 11.35% | (5.96%) |
| MB | 27.75% | 13.88% | 6.53% |
| NB | 29.82% | 14.91% | 1.10% |
| NL | 29.50% | 14.75% | 11.29% |
| NS | 30.48% | 15.24% | 9.12% |
| NT | 23.60% | 11.80% | (4.03%) |
| NU | 22.00% | 11.00% | 2.03% |
| ON | 24.15% | 12.08% | (1.20%) |
| PE | 28.80% | 14.40% | 4.53% |
| QU | 32.53% | 16.26% | 11.43% |
| SK | 27.50% | 13.75% | 2.04% |
| YT | 21.40% | 10.70% | (7.78%) |
As your income grows, your tax rate will also increase since Canadian tax brackets have increasing rates. In all cases, capital gains and dividend income clearly beat ordinary income.
Check out the same table for $100,000 in income.
| $100,000 Ordinary Income |
$100,000 Capital Gains |
$100,000 Eligible Dividends |
|
| AB | 30.50% | 15.25% | 10.16% |
| BC | 32.79% | 16.40% | 7.96% |
| MB | 37.90% | 18.95% | 20.53% |
| NB | 37.02% | 18.51% | 20.67% |
| NL | 36.30% | 18.15% | 20.67% |
| NS | 38.00% | 19.00% | 19.50% |
| NT | 32.70% | 16.35% | 8.53% |
| NU | 29.50% | 14.75% | 12.38% |
| ON | 37.91% | 18.95% | 17.79% |
| PE | 28.80% | 14.40% | 4.53% |
| QU | 32.53% | 16.26% | 11.43% |
| SK | 27.50% | 13.75% | 2.04% |
| YT | 21.40% | 10.70% | (7.78%) |
The Most Tax Efficient Investment
Plainly put, during the accumulation years an investment with only capital gains is the most efficient as you don’t pay until you sell. You essentially defer your taxes to much much later.
It’s almost like an RRSP without the tax refund and with a better tax rate upon withdrawal since the RRSP will be treated like ordinary income while your taxable account will pay the capital gains tax rate.
Say you buy stocks in a handfull of companies and hold them for 30 years before you sell, you won’t pay taxes until you sell.
With a dividend stock, you still get to grow your holding and pay capital gains later but you also pay taxes on your annual dividends.
The Most Tax Efficient Withdrawal Strategy
Once you understand the tax rates, you need to make decisions on your withdrawal per accounts since you never really just earn capital gains or simply dividends. You will hopefully earn a mix of the three sources of income.
- Ordinary income from RRSP/RRIF/Pension
- Various taxable investments from your non-registered account
- Tax-free withdrawal from your TFSA
Here is my portfolio by account type ratios for both spouses.
| Accounts | Income % | Value % | Taxes |
|---|---|---|---|
| TFSA | 17.54% | 21.69% | No Taxes |
| RRSP | 30.98% | 53.23% | As Income |
| Taxable | 47.20% | 25.08% | Capital Gains, Dividends |
OAS and CPP will come into play at a certain age and will be treated as ordinary income once you take it.
As for the most efficient withdrawal strategy, there are none. It’s really just about ensuring you make the best strategic decision to keep your income taxed in the lowest bracket where possible.
Advanced Tax Strategy
There are some advanced tax strategy you can plan for early on, or consider at some point. For couple, you want to try to balance the RRSP between the spousal through the use of a spousal RRSP.
At some point after your spouse, or common-law partner, is 65 years old, you can also plan for income splitting.
After-Tax Income
In the end, once you are retiring, it’s about your after-tax income and your tax bracket.
Based on my portfolio setup seen below, I will have to withdraw RRSP at some point in combination with my taxable dividends. Even if I just withdraw income from my RRSP portfolio, it will be taxed as ordinary income.
| Accounts | Income % | Value % | Taxes |
|---|---|---|---|
| TFSA | 17.54% | 21.69% | No Taxes |
| RRSP | 30.98% | 53.23% | As Income |
| Taxable | 47.20% | 25.08% | Capital Gains, Dividends |
Why Not Focus On Capital Gains Alone?
You certainly can and approach your retirement with the 4% withdrawal strategy. Many investors do that.
However, you then need to really plan your equity portfolio vs cash portion. Imagine retiring in 2020 when the market dropped … Do you have enough cash for 1 year? or 2 years?
If you think of doing capital gains only and then switch to dividends, you will have a tax bill to pay on the conversion at the time. The transition plan needs to be thought out to avoid a massive tax bill at one point.
