How tax affects your investment income
You’ve saved enough money to start investing it—well done! Now you need to know how the income on your investments is taxed.
To help you understand the tax implications, let’s first look at the difference between income earned from registered and non-registered savings.
Registered savings plans
Some of the best known registered plans are RRSPs and RRIFs. Money invested in these plans can grow tax free. However, when you start drawing down your plan, withdrawals are fully taxable.
Another registered option is a tax-free savings account (TFSA). With a TFSA, you pay no tax on income you earn (interest, dividends and capital gains). But it’s important to follow the rules on contributions and withdrawals.
This means savings that are not registered in a government plan like a TFSA or RRSP. Your money could be invested in any type of vehicle, such as term savings, mutual funds, shares or bonds. There are no government restrictions on deposits and withdrawals.
How investment income is taxed
Income earned outside a registered plan is taxed differently depending on the type of investment:
- Interest is taxed annually. In the case of investments with a guaranteed interest rate at maturity, you still need to pay tax on interest every year, even if no interest has been paid out yet.
- A capital gain (or loss) means the profit or loss on the sale of assets. This is taxable (or deductible) at 50%. For example, if you buy a share at $12 and sell it for $20, you’ll have a capital gain of $8, but only $4 is taxable. On the other hand, if you buy a share at $31 and sell it at $25, your capital loss is $6. This means you can claim a $3 deduction. You can also use a capital loss to offset capital gains on your tax return.
- Dividends are payments made by a company to shareholders based on the proportion of shares they each hold. Dividends are taxable the same year they are declared and entitle shareholders to a tax credit.
Find out more about the taxable amount of dividends.
Choosing registered or non-registered savings
To find the best option for you, it’s worth thinking about how investment income is taxed.
Fixed-income products, like term savings and bonds, generate regular interest income.
- Because interest is taxed at a higher rate, there’s a certain advantage to keeping this type of investment in a registered plan, like a TFSA or RRSP.
Investment securities, like stocks and mutual funds, can generate dividends and capital gains.
- Dividends and capital gains are taxed at a lower rate. This means it might be an advantage to hold this type of investment outside a registered plan, since the taxes won’t greatly reduce your return.