TSI Network Canadian Investor’s Tax Guide 2015

One of the best ways for investors to minimize and defer taxes is to buy good stocks and not trade frequently.

Gains on stocks generally come in one of two forms: dividends and capital gains. Both are taxed a lot lower than interest, which is fully taxed at the rate on ordinary income (see page 10).

You’ll pay tax on dividends in the year you get them, if you hold the shares outside your RRSP or TFSA. However, dividends on Canadian companies receive favourable tax treatment in Canada, thanks to the dividend tax credit (page 10). In fact, the tax treatment is so advantageous to Canadian investors, that you can earn up to $49,284 a year in dividends if that’s your only income….and not pay any tax (page 12)!

Just as important, you’ll defer all capital gains taxes on stocks you own until you sell and, even then, only pay taxes on capital gains at half the rate you pay on ordinary income (page 9).

Another key to cutting your tax bill is splitting income with a spouse. This includes spousal RRSPs and much more (page 4).

There are many simple ways for Canadian investors to cut their tax bills, and secure a better financial future:

Registered Retirement Savings Plans (RRSPs) are a great way for investors to cut their tax bills and make more money from their retirement investing.

RRSPs are a form of tax-deferred savings plan. RRSP contributions are tax deductible, and the investments grow tax-free. (Note that you can contribute up to 18% of your earned income from the previous year, to a maximum of $24,930 in 2015). March 1, 2016, is the last day you can contribute to an RRSP and deduct your contribution from your 2015 income.

When you later begin withdrawing the funds from your RRSP, they are taxed as ordinary income.

Here are two surefire ways to make the most of your RRSPs

Here are 2 retirement investing strategies you can use to make the most of your RRSPs, both now and in the future:

1. Keep higher risk investments outside of your RRSP: We continue to believe that holding higher-risk stocks in your RRSP is a poor retirement investing strategy. That’s because if you hold them in an RRSP and they drop, you not only lose money, but you also lose the tax-deduction value of a loss in your RRSP. Outside your RRSP, you can use capital losses to offset taxable capital gains in the current year, the three previous years, or any future year.

You also lose the opportunity for tax-free compounding that the money would have enjoyed within your RRSP. This is a crucial part of successful retirement investing. That’s because, after about 7 years in an RRSP, the ability of an RRSP contribution to grow and compound free of tax is usually worth more than the initial contribution itself. That’s why RRSPs are a bad place for aggressive investments of any kind. The potential losses that these investments could suffer are just too costly.

1. Consider RRSP withdrawals only in years of little or no income: Making early withdrawals from your RRSP only makes sense when you’re in a low income-tax bracket, and you have exhausted all other means of income. That includes periods when you are ill, say, or unemployed.

Spousal RRSPs are currently one of the only means of income splitting for couples.

If one spouse has a significantly higher income now, or expects to have a significantly higher retirement income, then you should look at taking advantage of a spousal RRSP.

Set up a spousal RRSP: Registered retirement savings plans, or RRSPs, are a form of tax-deferred savings plan designed to help investors save for retirement. RRSP contributions are tax deductible, and the investments grow tax-free. (Note that you can contribute up to 18% of your earned income from the previous year to a maximum of $24,930).

When you later convert your RRSP to a registered retirement income fund (RRIF) and begin withdrawing the funds, they are taxed as ordinary income.

A spousal RRSP is one way to achieve equal retirement income. Suppose you are the higher-income spouse. You can make contributions to a spousal RRSP, and claim the tax deduction. Your contributions to the spousal RRSP will count toward your annual RRSP deduction limits.

Your spouse can still contribute their full deduction to their own separate RRSP. When the money is withdrawn from the spousal RRSP years later, it is taxed in the hands of your spouse. That’s an advantage if he or she is still in a lower tax bracket.

A spousal RRSP is also a way to defer taxes if you are no longer able to contribute to a personal RRSP because of your age. As long as your spouse is 71 or younger, you can contribute to his or her spousal RRSP and still claim the tax deduction.

Note that withdrawals from a spousal RRSP are generally subject to a ―three-year rule.‖ If a spouse withdraws funds from an RRSP within three calendar years after the higher-income spouse’s last contribution, the higher-income spouse must declare the withdrawal as income on his or her tax return. The exceptions include spouses living apart due a marriage breakdown and the death of the contributor in the year a withdrawal is made.

Pay interest on your spouse’s investment loans: If the lower-income spouse takes out an investment loan from a third party, such as a bank, the higher-income spouse can pay the interest on that loan.

For example, say you’re the higher-income spouse and you make an interest payment on your spouse’s investment loan. As long as you don’t repay any of the loan principal, you do not have to claim any of the investment return on your income taxes. You should, however, make sure to pay the interest with a personal cheque bearing your name, so it’s directly tied to you.

The lower-income spouse would then deduct the interest payments on the loan on his or her tax return, even though the higher-income spouse paid them. This strategy lets the lower-income spouse build up a larger investment base.

One way to cut your tax bill in retirement is for you and your spouse to arrange the family finances so that you each have equal retirement income.

That’s because, if one spouse earns more than the other, the higher-income spouse would, of course, be in a higher tax bracket. That means that any extra money the higher-income spouse earns on investments, such as through capital gains, interest or dividends, would be taxed at a higher rate. So, you can lower your family’s overall tax bill by aiming to have both spouses in the same tax bracket.

The Canada Revenue Agency won’t let you lower your income tax by simply giving invested funds to a lower-income spouse. ―Attribution‖ rules apply if you do that. That means the higher-income spouse must pay tax on any gains or investment income from those funds.

Below are three simple income-splitting strategies. They’ll save you taxes both now and on future retirement income.

Have the higher income spouse pay the household bills: The easiest way to even out income between two spouses is to have the higher-income spouse pay the mortgage, grocery bills, credit-card bills, medical costs, insurance and other non-deductible costs of family life.

Remember that you have to keep separate bank accounts and accurate records. The higher-income spouse can also pay the lower-income spouse’s tax bill each spring, and any instalments that are due during the year.

All of these measures will let the lower-income spouse build a larger investment base. The lower-income spouse will pay less tax on any investment income compared to the higher-income spouse.

There’s no direct way to take money out of an RRSP without paying income tax at the rate on ordinary income.

You can make your contributions to a spousal RRSP (see above) so that when the money is withdrawn years later, it is taxed in the hands of your spouse who may be in a lower tax bracket than you are. It’s a good idea to plan things so that you use spousal RRSPs to split your retirement income between yourself and your spouse.

That can lower the total tax burden on your retirement income as a couple.

Another way to lower the overall tax burden on your RRSP withdrawals is to make withdrawals in low-income years—even if you don’t need the money in those years. You’ll then lose the tax shelter advantage of the RRSP on future earnings, of course. But you may save tax in the long run, particularly if you invest your RRSP withdrawals in stocks that you hold on to for many years, or in a TFSA (see below).

It’s possible to use your own RRSP funds to make a mortgage loan on a home you are buying, and gradually pay it back to your RRSP. But in view of the fees involved, it may be cheaper in most cases to get a mortgage from a conventional lender.

TFSAs

TFSAs let you earn investment income—including interest, dividends and capital gains—tax free.

You can contribute a maximum of $5,500 to your TFSA in 2015 and each year after. However, if you have not contributed in the past, or did not meet maximum contributions in any given year, you can catch up on unused contributions. (Up to the $36,500 limit as of the 2015 calendar year, or $5,000 per year from 2009 to 2012 and $5,500 per year from 2013 to 2015.)

Use your tax-free savings account to complement your RRSP.

Your TFSA can generally hold the same investments as an RRSP. This includes cash, mutual funds, publicly traded stocks, GICs and bonds.

Contributions are not tax deductible, as they are with an RRSP. However, withdrawals from a TFSA are not taxed. This makes the TFSA a good vehicle for more short-term savings goals. If funds are limited, you may need to choose between RRSP and TFSA contributions. RRSPs may be the better choice in years of high income, since RRSP contributions are deductible from your taxable income. In years of low or no income—such as when you’re in school, beginning your career or between jobs—TFSAs may be the better choice.

Investing in a TFSA in low income years will provide a real benefit in retirement.

When you’re retired, you can draw down your TFSA first, then begin making taxable RRSP withdrawals.

Hold low-risk investments in your tax-free savings account.

We think you are best to hold lower-risk investments in your TFSA. That’s because you don’t want to suffer big losses in these accounts. If you do, you can’t use those losses to offset capital gains. You’ll also lose the main advantage of a TFSA: sheltering gains from tax. You won’t have gains to shelter if the value of your investments falls.

p>If you are just starting a TFSA, you likely won’t have enough funds to build a diversified portfolio within these accounts. That’s why you are best to hold lower-risk and low-fee equity investments. These include interest-bearing investments, like high-yield savings accounts such as those from President’s Choice Financial or Tangerine, or index funds.

A tax-free savings account-friendly index fund.

One example of a suitable index fund is the iShares S&P/TSX 60 Index ETF (Toronto symbol XIU). The fund’s units are made up of stocks that represent the

S&P/TSX 60 Index, which consists of the 60 largest, most heavily traded stocks on the exchange. Most of the stocks in the index are high-quality companies.

The units trade on the Toronto exchange, just like stocks. Prices are quoted in newspaper stock tables and online. You’ll have to pay brokerage commissions to buy and sell them, but you will quickly make these back because of the low management fees, which are just 0.17% of the fund’s assets.

Take the long view with TFSAs.

Over the years, as the value of your TFSA increases, you could switch to a well-diversified portfolio of conservative, mostly dividend-paying stocks, or ETFs that hold those stocks.

There are three principal forms of income from investments in Canada: interest, dividends and capital gains. Each is taxed differently. Smart investors can use that to their advantage.

What is capital gains tax?

You have to pay capital gains tax on profit you make from the sale of an asset. An asset can be a security, such as a stock or a bond, or a fixed asset, such as land, buildings, equipment or other possessions. However, you only pay the tax on a portion of your profit. This is called the ―capital gains inclusion rate‖.

Let’s look at an example. Say you purchased 1,000 shares of TD Bank at $20 per share many years ago, and when it reaches $60 per share, you decide to sell. Your proceeds from the sale are $60,000 ($60 per share multiplied by 1,000 shares) and your cost (the cost of purchase) is $20,000 ($20 per share multiplied by 1,000 shares). This means that your profit on the sale, also known as your capital gain, is $40,000.

Capital gains: A tax-advantaged form of income

Several years ago, the Canadian government cut the capital gains inclusion rate

(the percentage of gains you need to ―take into income‖) from 75% to 50%.

This further enhanced the favourable tax treatment that capital gains are given in Canada. You only pay tax on 50% of the amount of your capital gain. So, based on the TD example above, the amount of your taxable capital gain is only $20,000 ($40,000 multiplied by 50%). If your tax rate is 50%, you would pay $10,000 in taxes ($20,000 in taxable capital gains multiplied by a 50% tax rate).

Interest income

Interest income is fully taxable, so that same income of $40,000 at a tax rate of 50% would cost you $20,000 ($40,000 in interest income multiplied by a tax rate of 50%). That’s double what you would pay on the income from a capital gain.

Dividend income

Dividend income is eligible for a dividend tax credit in Canada. Factoring that into the tax rate payable on dividends, you’ll pay 29.52%, or $11,808, on $40,000 in dividend income.

So, if you structure your portfolio so that more of your taxes are on capital gains (and on dividends) than on other types of income, you will pay less tax overall. Of course, all forms of income have their place in a properly planned portfolio, but by planning ahead you can minimize your overall tax burden and maximize the money you save (and the size of your investment portfolio).

With the market rebounding while interest rates remain near historic lows, borrowing money to invest still looks attractive.

That’s especially true if you borrow to buy some of Canada’s best dividend stocks.

These investments will give you regular dividend income and cash flow to pay the interest on your investment loan. In funds like these, you’ll also benefit most from a longer-term stock-market rise.

Borrowing to invest can pay off, especially if you stick with the best dividend stocks.

Today, you can borrow for as little as 3.50% if you use your home as collateral. Over long periods, the total return on a well-diversified portfolio of Canada’s best dividend stocks and high-quality mutual funds run to as much as 10%, or around 7.5% after inflation. So you can expect to earn more than your borrowing cost.

Borrowing to invest is not without risks. The amount you owe on your investment loan will stay the same, regardless of what the market does, so every dollar your portfolio loses will come out of your equity. In addition, if you take out a variable-rate loan, the interest rate you pay could eventually rise.

On the plus side, borrowing to invest can be a highly effective tax shelter. You can deduct 100% of your interest expense against your current income. Plus, the investment income you earn comes with three key tax advantages: you get the dividend tax credit on qualified Canadian stocks and you only pay income tax on 50% of your capital gains.

In addition, you are only liable for capital gains when you sell; if you buy high-quality investments, you’ll wind up holding some of them for as long as you live. It’s a great tax-deferral technique. And it’s perfectly legal.

Six ways to tell if borrowing to invest is right for you.

Borrowing to invest only makes sense if all six of the following apply:

1. You are in the top income-tax bracket and expect to stay there for a number of years;

1. Your income is secure;

1. You have 10 or more years until retirement;

1. You follow our low-risk investment approach;

1. You have the kind of temperament to sit through the inevitable market setbacks without losing confidence at a market bottom and selling out to repay your loan;

1. You have already made your maximum RRSP contributions.

If you have no other income, you can make up to $49,284 in Canadian dividends in most provinces (see chart on the last page of this report) without paying any income tax.

Here’s how it works:

When you make $49,284 in Canadian dividends, you are required to ―gross‖ that up by 38% when you report it on your tax return. So the $49,284 becomes $68,012.

The combined federal and provincial tax on $68,012 is then $16,379 ($11,834 federal and $4,545 provincial). The tax payable is low because with no income other than the dividends, the federal rate on the first $44,701 of income is just 15% and 22% on the next $44,700. The provincial rate (in Ontario for example) on the first $40,922 is 5.05%, and then 9.15% on the next $40,925.

However, Canadian dividends are eligible for a federal dividend tax credit equal to 15.02% of the grossed up dividends, and a provincial tax credit (in Ontario) equal to 6.4% of the grossed up dividends. That’s a total of $14,588 credit on $68,102 of grossed up dividends.

Plus, each individual also gets a basic personal tax credit that totals $2,159 (15% of the $11,138 basic federal personal amount and 5.05% of the basic provincial amount in Ontario of $9,670).

Adding it all up:

You owe $16,379 in federal and provincial tax. But you get total dividend tax credits of $14,588, plus $2,159 in total basic personal tax credits. Add those together, and the $16,747 more than offsets the $16,369 in total tax. (The $378 positive difference is a non-refundable credit, so you won’t get that back.)

Canadian dividends received: $49,284
Grossed up dividends (times 1.38): $68,012

Taxes payable on $68,012:
Federal - $11,834
Provincial - 4,545
Total Payable: $16,379

Tax credits:
Federal tax credit (15.02% of $68,012) - $10,229
Provincial tax credit (6.4% of $68,012) - $4,359
Personal tax credits—Federal & provincial - $2,159
Total Credits: $16,747

Total credits of $16,747 exceed your total payable of $16,379…..so you pay NO TAX!

Taxation Tables

• Personal Table
• Combined Top Marginal Tax Rates
• Individual Marginal Tax Rates for Salary
• 
  Individual Marginal Tax Rates for Interest
• Individual Marginal Tax Rates for Capital Gains
• Individual Marginal Tax Rates for Eligible Dividends
• 
  Eligible Dividend Tax Credit Rates & Amount of Dividends Table