When to report interest on market-linked guaranteed investments
The performance of a market-linked guaranteed investment depends on the evolution of 1 or more stock market indexes, or on the performance of a portfolio of financial assets (equity, fixed income securities, etc.). The capital invested is 100% guaranteed, and maturities generally range from 35 to 5 years.
Usually, interest income on a non-registered investment must be reported each year. However, the interest earned on market-linked guaranteed investments is taxed only at maturity, when the return can be calculated with certainty.
Here's how the income on these investments must be reported.
Example 1: conventional, no fixed-return option
- You invested $1,0005 in a "Stock ABC" guaranteed investment (fictitious name) issued in 2007 for a 3-year term.
- Since the return was not known prior to 2010, you reported nothing on your 2007, 2008 or 2009 income tax returns.
- At maturity, the return was determined to be $450.
- You then had the option to include this interest on your tax return for 2010 or defer taxes on this income for up to 35 years.
Example 2: with fixed-return option
- You have a "Stock ABC" guaranteed investment in the amount of $1,0005 issued in December, 2007, for 3-year term, with a fixed-rate option available on the second anniversary date.
- In December 2009, you decide to exercise the fixed-rate option to hedge against an expected drop in the markets.
- Your financial institution then calculates the interest earned from December 2007 to December 2009, for example $219.
- Your financial institution forwards you a tax form for the 2009 tax year.
- You must include this amount in your 2009 income, even if you have not yet received it.
- In 2010, you receive the total interest, calculated at $346. As you have already declared a part of this amount, the tax slip indicates only $127, i.e., the interest earned from December 2009 to December 2010.
- You must include this amount in your 2010 income.
Example 3: enhanced return
An enhanced return guaranteed investment guarantees a minimum annual return, paid either monthly or annually (determined in advance).
- You invested $1,000 in a "Stock LMN" enhanced return guaranteed investment issued in 2007 for a 3-year term.
- You receive an annual tax slip showing the amount to include in your income, even if you have not yet received the income.
- In 2010, you receive all accrued interest, but you declare only the interest earned since the last anniversary date.
Investing the interest in an RRSP
Even if the income on your market-linked guaranteed investments is only taxable at maturity, why not invest it in an RRSP? This way, taxes on the interest will be deferred until withdrawal from the RRSP.
When your RRSP matures, at the latest at the end of the year you reach age 71, you can transfer your market-linked guaranteed investments to a RRIF. However, your RRIF will have to include sufficient liquidity to allow you to make the minimum annual withdrawal.
If, when your RRSP matures, you choose to purchase a fixed annuity or lifetime annuity with the full amount available, you cannot hold market-linked guaranteed investments.
The TFSA: a good strategy
If you decide to include market-linked guaranteed investments in your Tax-Free Savings Account (TFSA), the timing of taxation will no longer be an issue since this account is designed to generate income that will never be subject to tax.
