As anybody North of the 49th will tell you, there are certain aspects of being Canadian that we all revel in.
Paying tax is not one of them.
With tax season just passed, it seems like a good time to take a look at the various ways the government pries your investment return dollars out of your wallet.
When I was first getting into investing, I invested a lot of money into a Mortgage Investment Corporation. It provided quite good monthly returns, and I can still remember being pretty pleased with myself that the investment was throwing off almost $500 a month. Tax time brought a cold shower, a slap in the face, and a wakeup call all rolled into one. Unlike taxes paid on working income, investment taxes are all paid once annually, at tax time. At this point, I don’t remember exactly what the tax hit was, but for a person of my modest income, it was substantial. Coincidentally, it was about that time that I became aware of a fact that has had a major impact on my investing practices since then.
Canadian tax rates for investment income: Different source of income, different tax rate
Since a dollar is worth the same regardless of where it comes from, it would be logical to assume that a person would be taxed equally on all sources of income. Logical, but incorrect. In fact, where you get your income from can make a huge difference in how much of that money you get to keep, and how much gets claimed by Ottawa. Canadian tax rates for investment income are absolutely not all created equal.
Here is the least you need to know: Dividends almost always attract a lower rate of taxation than capital gains (the higher your income, the less true this is) and dividends always attract a lower rate of taxation than interest. Income earned from working a job is (here’s a big surprise) the least effective way to earn money because you not only have to pay taxes at the same rate as interest income, but you also have to add CPP, EI, and other deductions to the calculations. While these are not technically taxes, the fact is that it’s money that the government collects and spends, leaving less in your pockets.
Where do you live? How much do you make?
Canadian tax rates vary depending on your province of residence and income. Rather than provide a national average, or assume that everybody lives in Ontario, I’ll instead provide a link to where you can look up your own rates. Don’t look for a column titled Interest Income because you won’t find it. All income that is not capital gains or dividend income is treated the same, and is under the Other Income heading.
Don’t want to do the math? Go to this site with tax information. Enter your income in the box near the top, and see how you’ll be taxed, depending on where you live.
So, what do you do if your investments are being taxed as interest? You have three choices. 1) Pay a high tax rate; 2) Move that investment into a registered account (RRSP or TFSA) to defer or eliminate taxes, or; 3) Sell the investment, and instead invest in dividend-paying stocks.
When faced with this choice, I chose the third option, and I’m glad I did. Interest rates over the past few years have made it more difficult to squeeze a good return out of MIC’s. Also, I got lucky, and first entered the stock market only about two months before the bottom in 2009, so I’ve been able to pretty-much have it all: relatively good dividend yields, capital appreciation, and much lower tax rates.
Even if your timing isn’t quite as fortuitous as mine was, the second two advantages will still be working for you over the long term.