Investment Strategies

TFSA

Tax Free Savings account is available to all Canadians when they turn 18 years of age. There is no tax deduction for contributions to your TFSA like there is for an RRSP. However, any income (interest, dividends, capital gains) made within an TFSA are not taxed when earned or when withdrawn and can be withdrawn at any time. 

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This makes your TFSA the ideal vehicle for high growth investments such as stocks. It is ideal to build up the balance in your TFSA as early in your life as possible. This will allows you to shelter the gains made on your investments from taxes while also allowing you the flexibility to withdraw money at any time in the event of a large purchase or emergency without consequence.

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For investors with a long time horizon, it can be more beneficial from a tax perspective to hold investments in a TFSA over an RRSP.

RRSP

A Registered Retirement Savings Plan is an excellent tool to help reduce taxes for Canadians who are in a high tax bracket.  Contributions made to an RRSP can be deducted from a taxpayers net income for tax purposes resulting in less taxes payable in the year the contributions are made.

Once the contributions are withdrawn, the withdrawals are included as part of the taxpayers income in the year withdrawn. Ideally, a taxpayer will contribute to an RRSP during their prime earnings years to reduce their income while in a high tax bracket. Then once a taxpayer retires or stops working, the contributions can be withdrawn slowly and taxed in a lower tax bracket.

Money held within an RRSP can be invested and appreciate in value. Those gains (capital gains, dividends, interest) will not be taxed until that money is withdrawn from the RRSP.

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The disadvantage of the RRSP is that the preferential tax treatment of investment income is lose. Capital gains are not given the 50% tax treatment when earned in an RRSP. Dividends earned in an RRSP do not yield a dividend tax credit. Both capital gains and dividends are taxed 100% as income when withdrawn from an RRSP.

Canadian Dividends

Canadian dividends will fall in one of two categories: 

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1) Eligible Dividends-dividends received from Canadian companies trading on the Toronto Stock Exchange (TSX). Eligible dividends are grossed-up to 138% of the original amount for tax purposes. A valuable dividend tax credit is awarded when receiving a Canadian dividend. For eligible dividends in Ontario, this credit is equal to 25.0198% (combined Federal and Provincial credit) of the grossed up dividend amount. 

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Due to this dividend tax credit, Canadians living in Ontario with no other income can earn up to $73,450 (as of 2020 tax year) in eligible dividends without having to pay a single dollar in taxes!

For individuals with no other income or total income under $49,020, it can be advantageous to hold stocks outside of tax sheltered accounts like a TFSA or RRSP to receive the benefits of the dividend tax credits that would otherwise be lost within those accounts.

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2) Ineligible Dividends-Ineligible dividends are dividends that you may receive from a Canadian corporation that is not publicly traded on the TSX. This maybe a small business that you own. 

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Ineligible dividends also include a 115% gross-up and 12.0164% dividend tax credit. Because the credit is much smaller, ineligible dividends do not offer the same tax advantages of eligible dividends.