Minimize Interest and Foreign Income
Tax-efficient investing is a strategy focused on minimizing the taxes paid on investment returns, ultimately maximizing the after-tax returns for investors.
Tax-efficient investing involves maximizing the benefits of tax-deferred and tax-sheltered plans such as the Registered Retirement Savings Account (RRSP) and tax-exempt accounts such as the First Home Savings Account (FHSA) and Tax-Free Savings Account (TFSA). Tax-efficient investing includes investments that take advantage of the lower tax rate on certain types of income and asset location, such as using corporate class funds in non-registered accounts, which may combine taxable gains, losses, income and expenses from all the funds inside a corporation to minimize the net taxable distributions for the mutual fund.
Tax-efficient investing includes tactics such as tax-loss harvesting, where capital losses are strategically realized to offset gains, and careful consideration of the timing of purchasing or redeeming assets to reduce capital gains taxes.
Tax-Deferred or Tax-Sheltered
Choosing between a tax-deferred (RRSP) and a tax-sheltered account (FHSA and TFSA) depends on your financial goals, income level, and current and future tax situation.
What is asset allocation vs asset location?
Asset allocation is the breakdown of how much proportionally you hold in different asset classes (e.g. equity and fixed income).
This is the main driver of your investment return in the long term.
Equities outperform any other asset class over a long period of time.
For those without pensions, a conservative allocation is the traditional 60/40 equity to fixed income split used historically by pension funds to provide for retirement income.
For those with a pension, you can take on more risk and therefore recommend 70/30 or 80/20 split.
The specific recommended allocation will be based upon the individual’s situation and preferences.
Asset location is the account type in which you hold different classes. This can have meaningful tax implications.
Given that any growth in your TFSA is tax-free, your most volatile or risky investments that are expected to appreciate the most should be held within the TFSA
Your fixed income and capital preservation investment products should be held inside RRSP and RRIF where any gains and interest will be taxed fully.
FHSA combines the best contribution deductions of RRSPs and tax-free withdrawals for home purchases. When selecting investments to be held in RRSP/RRIF or TFSA, consider that each double in RRSP/RRIF—eventually withdrawn as regular income at the full marginal tax rate.