Tax Efficient Investing

Allegiance Wealth Management

Money that is saved from taxation could produce substantial positive impact to your overall financial plan. Although death and taxation are things we cannot avoid in life, there are ways to reduce taxation and minimize the effect of it. Tax efficiency is an important consideration when accumulating wealth or taking income from assets. Planning for tax efficiency in your financial plan is to analyze your current tax situation, identify possible tax reduction strategies, and incorporate solutions that will keep taxation to the minimum.

Taxation of Investment Income

Interest Income

Interest and other income (including rental income) are the most tax inefficient income since they are fully taxable. Interest income is earned on fixed-income investments like treasury bills, bonds and mortgages. Rental income, likely earned by owning the real estate properties, is also fully taxable. The taxable portion of these incomes is 100%.

Dividend Income

Dividends are the portion of a company’s profits distributed to shareholders. They’re earned on equity investments such as common or preferred shares. Generally there are two types of dividend income, eligible and ineligible. Eligible dividends are those paid by public corporations. Ineligible dividends are those paid by small business corporations. The taxable portion of eligible and ineligible income is about 50% and 75% respectively.

Capital Gains

Capital gains are created when a capital asset’s value increases. The gains are taxable when they’re realized; that is, when the asset is sold for cash, used to purchase other units or deemed to have been sold. Capital gains are included in taxable income at one-half the actual gain. The taxable portion of capital gains is 50%.

Foreign Income

Dividend and interest income from foreign companies is taxed in the same manner as interest income (100% taxable). Owning U.S., global and international equity could earn this kind of income. The tax slip may also indicate foreign taxes paid, which may be eligible as credit towards income tax payable in Canada.

Return of Capital

Return of capital (ROC) distribution from an investment is not considered taxable income. A ROC occurs when some or all of the money an investor put into an investment is paid back to him or her, decreasing the principal amount of the investment. The investor has to reduce the adjusted cost base of the investment by all ROC payments. Individuals are not taxed on return of capital until it begins to exceed the original investment value.

2011 Personal Income Tax Table – Top Marginal Tax Rates
Province Interest & Other Income Capital Gains Eligible Dividends Ineligible Dividends
B.C 43.70% 21.85% 23.91% 33.71%
Alberta 39.00% 19.50% 17.72% 27.71%
Sask. 44.00% 22.00% 23.36% 32.08%
Manitoba 46.40% 23.20% 26.74% 39.15%
Ontario 46.41% 23.20% 28.19% 32.57%
Quebec 48.22% 24.11% 31.85% 36.35%
N.B. 43.30% 21.65% 20.96% 30.83%
N.S. 50.00% 25.00% 34.85% 36.21%
P.E.I. 47.37% 23.69% 27.33% 41.17%
Nfld. 42.30% 21.15% 20.96% 29.96%
N.W.T. 43.05% 21.53% 21.31% 29.65%
Yukon 42.40% 21.20% 17.72% 30.40%
Nunavut 40.50% 20.25% 25.72% 28.96%

Tax Efficient Growth

When you try to accumulate wealth, taxation can be a stumping block. Taxation will slow down the growth of wealth. Although eventually taxation is unavoidable, we can still minimize and defer it to maximize outcome of wealth accumulation. Planning and solutions that offer significant tax efficiency:

Registered Retirement Savings Plan (RRSP)

A tax assisted program which provides tax deduction on your contributions. Tax deduction means less tax for your income as taxable income is reduced by tax deduction. The assets that are accumulated within the plan are tax sheltered. In another word, any investment gains or income are not subject to taxation within the plan. You can grow your savings inside an RRSP without immediate taxation until upon withdrawal. Using RRSP to save money is a tax efficient way to prepare for long-term savings goals such as retirement, home purchase, and lifelong learning purposes.

Tax Free Savings Account (TFSA)

A registered tax free savings plan as the name itself has described. Each year, you can save up to $5,000 in TFSA. All types of investment income are free from taxation. Assets you have accumulated in the TFSA can be withdrawn without any taxation. There are many planning opportunities to use TFSA as a primary savings vehicle especially during time when your tax rate is low.

Corporate Class Investment Funds

Corporate Class funds are a type of investment funds held under a corporate entity as opposed to a trust. Using this structure, the funds are considered different classes of shares in a corporation, which results in three key advantages: tax deferred switches, potentially lower annual distributions, and tax effective income. Using this type of investments outside of a registered savings or income plan can reduce taxation significantly.

Tax-exempted Life Insurance

When you accumulate assets within a tax-exempted life insurance policy, such as whole-life participating and universal life insurance contract, gains within the policy are exempted from taxation. This type of life insurance not only provides tax free money in case of death but also allows growth of wealth on a tax efficient manner.

Tax Efficient Income

T-series Income Funds

This type of investment funds provides a tax-deferred monthly cash flow. T-series funds pay a percentage of tax efficient income from the investment on a regular basis. It improves your after-tax cash flow from non-registered investments. Since many government sponsored retirement benefits are income-tested, by reducing your taxable income will help to maximize the amount of these benefits. In another word, increase your retirement cash flow.

Insured Retirement Program (IRP)

The Insured Retirement Program (IRP) is a financial planning concept which provides tax deferred accumulation and tax-free income. By overfunding a tax-exempted life insurance policy and creating significant cash values, the concept illustrates how these values can be used to secure loans from a lending institution. The amounts borrowed can then be used to supplement retirement income, fund investments, make gifts, etc. The loan will finally be settled at death by the insurance policy.

Start minimizing tax today, contact one of our advisors to help you determining the most tax efficient strategy for your investments.