It's important you know that not all investment income is taxed equally.
Here are some strategies which may help you reduce your tax burden.
There are generally three types of investment income: interest income, dividend income and capital gains.
Interest income is taxed at your marginal tax rate attracting the least favourable tax treatment. Canadian dividend income is eligible for the dividend tax credit, which for most Canadians makes it a more favourable type of investment income when compared to interest income. Capital gains have an inclusion rate of 50% making it the most favourable type of investment income. Capital gains income is also only recognized when the investment is sold.
As a Canadian, you can invest in corporate class mutual funds.*
Corporate class mutual funds* provide two key benefits:
As the mutual fund* is set up as a corporation, it allows the mutual fund* to reduce or defer the tax you pay compared to mutual fund* trust. Reduced taxes means your money grows faster.
Tax-efficient cash flow
Many corporate class mutual funds* allow you to take your capital out of the mutual fund* (return of capital) before withdrawing your investment income, and in this way you defer taxes paid on earnings.
Corporate class mutual funds* are good for individuals who are concerned with taxes but do not have contribution room for a TFSA or RRSP contribution or for seniors who can no longer contribute to an RRSP.
Leverage government-sponsored savings plans to reduce your taxes.
RRSPs are ideal for saving for your retirement. Defer income from your highest income earning years to when you earn less and your marginal tax rate is lower. Also, taxes on your investment earnings are deferred until you take money out of your RRSP. Money withdrawn from an RRSP is taxed at your marginal tax rate.
Choose a TFSA for your short-term savings goals. Investment income in a TFSA does not attract any taxation and there is no tax consequences when you withdraw from the TFSA.
Set up an RESP so you can tax-efficiently save for your child’s education. Investment income generated in an RESP is sheltered from tax until withdrawn. When withdrawn, the investment income will be taxed in the student’s name, who presumably will have a lower tax rate. In addition, contributions to an RESP are eligible for government grants.