It’s not what you make — it’s what you keep

Making money on your investments is difficult enough in today’s uncertain markets. Why give away more than you have to in taxes? Here are some ideas to help you become a “tax-smart” investor and keep more of your hard-earned money.

1. Remember how investments are taxed

When considering the pros and cons of a particular investment, it is important to factor in its after-tax, rather than pre-tax, return potential. The reason? Different types of investment income receive different tax treatment.

• Interest income, such as income from bonds, is fully taxable at your marginal tax rate.
• So is investment income from any foreign source.
• Canadian-source dividend income is effectively taxed at a lower rate due to a tax credit.
• The most favourable tax treatment is generally reserved for capital gains, such as the profit made on the sale of a stock. Just 50% of a net capital gain is taxable in any given year.

You can reduce your taxes by offsetting capital gains with capital losses. No one wants to take a loss, but when it happens, it can be a little easier to accept if you can use it to reduce your tax liability. For example, if you sell one stock for a gain of $10,000 and another stock for a loss of $5,000, you would have a net capital gain of $5,000. And only 50% of the net capital gain is taxable — in this case, $2,500.

When considering this strategy, there are a few things to bear in mind:

• Realized capital losses must be used to offset capital gains realized in the same tax year.
• If a net capital loss remains in the year, it can be carried back and applied against capital gains in any of the three previous calendar years or it can be carried forward and used to offset capital gains in future years.

3. Consider investments with tax advantages

In response to a growing demand, there are several new “tax-smart” investment choices:

• “Corporate class” mutual funds that enable you to move assets between sectors, geographic areas and investment styles without triggering taxable capital gains.
• “Individually managed portfolios” that give you access to elite-level investment managers without sacrificing control over taxable events.
• “Low-turnover portfolios” that limit the number of times a taxable capital gain is triggered.

One of the best tax shelters available is, of course, your registered Retirement Savings Plan (RSP). Contributions to an RSP are deductible against your taxable income, and they grow on a tax-deferred basis.

Before implementing any tax strategy, please consult with a professional tax advisor.