How can investors reduce taxes on investments? TriDelta Financial’s Lorne Zeiler, Portfolio Manager and Wealth Advisor was one of two wealth management professionals interviewed by Globe and Mail reporter Terry Cain to answer this very question (article printed on March 1, 2017).
It’s an old saying but it still holds true – nothing is certain but death and taxes. However when it comes to investing and saving for retirement, there is plenty Canadians can do to minimize the amount they end up paying to the tax man.
First off, it’s important to realize just how important tax considerations are when planning your portfolio, experts say.
“Taxation in a non-registered portfolio is one of the major deterrents to building wealth,” says Carol Bezaire, senior vice-president of tax, estate and strategic philanthropy at Mackenzie Financial Corp. She notes that different types of investment income attract different tax treatment, so the portfolio being built should factor this in.
Interest income attracts the highest tax – on average in Canada, for every $1 earned in interest or foreign income about 50 cents goes to the government in tax. The dividends tax rate means on average 35 cents goes to the government for every $1 paid. Capital gains at the current 50-per-cent inclusion rate means on average 25 cents in tax is levied for every $1 in capital gains. “Paying attention to tax in a portfolio allows the investor to build wealth more effectively by paying less tax,” says Ms. Bezaire.
Lorne Zeiler agrees. Mr. Zeiler is a vice-president, portfolio manager and wealth adviser at Tridelta Financial. “Taxes are very important in determining how we structure our clients’ portfolios,” he says. He notes that many of his company’s clients are high-income earners and therefore in higher tax brackets, so taxes can have a big impact on their overall portfolio growth.
Mr. Zeiler says if clients have cash accounts, corporate accounts and registered accounts, his company allocates as many income-producing securities (such as bonds, GICs, and REITs) as possible to their registered accounts first, as taxes on investment income are substantially higher than on dividends or capital gains.
As far as specific tax-sheltered vehicles go, the place to start is the best-known options: registered retirement savings plans (RRSPs) and tax-free savings accounts (TFSAs). Mr. Zeiler says TFSAs are an excellent source to minimize tax, as any gains or income on investments within the TFSA are tax-free. For example, a couple taxed at the highest marginal rate with $125,000 in TFSAs invested in REITs paying a 6-per-cent return would save more than $4,000 annually in taxes.
RRSPs are ideal for tax minimization, as they offer the benefit of tax deferral and tax-free compounding, since taxes are paid only when the funds are withdrawn. Mr. Zeiler notes their biggest tax advantage is typically from tax arbitrage. Investors are often getting a tax credit for contributions made when they are in higher tax brackets, but then are charged taxes on withdrawals when tax brackets are lower.
Ms. Bezaire has a number of tips for tax minimization.
First, hold high-tax investments, such as interest-bearing vehicles (particularly foreign income) in a TFSA or RRSP so the interest can compound without taxation.
Next, look for investments where most of the return is through capital gains, since these receive the lowest tax rates. These investments can include stocks, mutual funds and ETFs.
Ms. Bezaire also highlights the tax-advantageous forms of mutual funds. She notes there are mutual funds that are structured as trusts and the portfolio earnings flow out net of expenses to investors. There are also corporate class funds that flow out only dividends or capital gains, never interest or foreign dividends, so these can be helpful to many investors by providing tax-efficiency. Finally there are T-series mutual funds. Most of the distributions from these funds are classified as tax-free return of capital payments, while the bulk of an investor’s savings can continue to grow in the fund.
Mr. Zeiler notes one of the areas where investors often do not do enough tax planning is their estate, as often the estate can be subject to significant taxes that could have been minimized.
Another overlooked area is planning for contingencies in the event that one spouse passes away earlier than the other. Mr. Zeiler says his company often uses insurance as part of the strategy to reduce taxes, particularly for the estate, especially if the investor’s holdings are structured as a corporation.
Mr. Zeiler also notes that income splitting is very important for retirees. By splitting income, marginal tax rates for the higher-income spouse can be reduced significantly and it can enable both spouses to earn their full Old Age Security (OAS) payments.
Ms. Bezaire also cites the value of income splitting, including selling some income-generating investments to a lower-income spouse by way of a spousal loan, using a spousal RRSP to save for retirement, pension income-splitting for seniors, or even the higher-income spouse gifting cash to a spouse who can then invest the money in a TFSA for the future.
There are two final issues to consider.
While tax considerations can be very important, Mr. Zeiler notes taxes should never drive an investment decision, such as deciding not to sell a security due to large capital gains owing.
He also highlights a related issue for many retirees: having a large position in a few securities that have substantial gains, such as owning Canadian bank shares for 20 years or more. For those clients, his company often looks at selling the shares over a period of time so that some capital gains are realized each year at a lower marginal tax rate instead of all at once.