How asset location affects taxes

Tax season is just around the corner, and as you gear up to write that cheque to the government, you’re probably realizing how much tax you owe on your investments.

As your portfolio grows, you are going to find you have more than enough money to fill up both your TFSA and RRSP. At this point, you’ll need to start making strategic decisions regarding your asset location. Asset location, is not usually widely discussed, but asset location refers to the type of accounts your capital is deployed in. For example, RRSP, TFSA, Non-Registered. Where as asset allocation, is the type of asset classes you are invested in (i.e. stocks, bonds, real estate, etc).

Where should your dividend yielding investments be? What is the best way to handle capital gains? If you’re going have non-registered investment holdings, what should they be?

The first thing to realize is that interest, dividends, and capital gains are all treated differently by the CRA. Interest is 100% taxable, whereas select dividends and capital gains are subject to preferential tax treatment.

Eligible dividends, which are received by Canadian companies, receive tax credits that decrease the taxable amount significantly, and only 50% of of your capital gains are taxable. These two deductions can save you a lot of money, so assuming you have enough interest-bearing investments to fill up your TFSA, you should keep them in there.

It gets a little more complicated with your RRSP, since your gains aren’t sheltered in the same permanent manner as your TFSA. Any income you pull out of your RRSP is taxed as employment income, which means interest income is effectively the same as dividends or capital gains. The RRSP and TFSA may have preferential tax treatment, but they also prevent any of the available tax deductions on those investments.

With this in mind, you would do well to put your interest-earning assets in your RRSP first, since you want your dividends and capital gains to benefit from the available deductions. However, if you don’t have enough interest-earning assets to fill it up, you would want to look at your expected returns on both dividends and capital gains, and move the assets least likely to benefit from deductions into your RRSP.

To address the various levels of risk, it may still make sense to have the investments most likely to generate capital gains in non-registered accounts. This is because any losses that occur within your RRSP or TFSA will not be deductible. No one plans to lose money, but it is nice when you can deduct losses against other gains in order to reduce your tax load.

This is where your Kismet wealth advisors come in. We regularly advise our clients on the tax optimized way to allocate their assets, while taking all case specific factors into account. If you’re worried you might be paying too much taxes on your portfolio, reach out to schedule a meeting with our Wealth Management team. In many situations, the money you save in one meeting ends up compounding for years to come.