By Jo Coughlin
Understanding how your savings are taxed will help you avoid unpleasant surprises at tax time.
1. Bonds
Bonds are attractive because they pay fixed interest, usually twice a year. They typically give you your money back when they expire. But be aware that their price can fluctuate, and they can fail. This would then leave you with years of interest income and possibly a partial or total loss of the money invested. You must add all bond interest on your tax return for the year in question when calculating your taxes. If you sell your bonds for a profit, you get a capital gain, and you must add 50% of this gain to your taxable income. Conversely, if you sell at a loss, you can use this loss to reduce your capital gains for a given year or carry this loss forward three years or on.
Should you buy bonds or invest in bond funds?
2. Shares
We invest in shares of a company for the dividends and hope that their price will rise. You have to pay capital gains tax when you sell shares for a profit. If you sell at a loss, you can use that loss to reduce your capital gains for a given year or carry that loss back three years or forward. Dividends receive preferential tax treatment and are taxed according to a formula based on your income and your province of residence.
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3. Mutual Funds
It is essential to know that mutual funds held outside of registered retirement savings plans (RRSPs) are taxed differently than those born in RRSPs.
Non-RRSP: Mutual fund earnings not part of a registered pension plan will be subject to tax, even if those earnings are reinvested. Depending on the investment, gains from mutual funds may be taxed as interest income, dividend income, or capital gains. Also, although withdrawals from non-registered mutual funds are not taxed, they may result in a capital gain or loss. To avoid surprises, ask your advisor before making a withdrawal.
In RRSPs — your earnings from mutual funds in RRSPs are tax-sheltered until you withdraw money from those funds. All amounts withdrawn from mutual funds in RRSPs are taxed as income.
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4. RRSP investments
It would help if you converted all your retirement savings plans into income by the end of the year you turn 71. In addition, you can no longer contribute to a registered retirement savings plan or a company pension plan. By December 31 of the year, you turn 71; you must convert your RRSPs into retirement income in one of the following ways:
Collect your savings. If you do, the total amount will be taxed, and that’s something you want to avoid.
Turn your savings into an RRIF.
Take out an annuity.
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5. Registered Retirement Income Funds (RRIFs)
The flexibility of the RRIF is a significant advantage. RRIFs allow you to choose how your money will be invested — for example, guaranteed investment certificates (GICs), accumulation annuities, mutual funds, segregated funds and other higher-risk options. You could even transfer your current investments to an RRIF. An RRIF requires you to withdraw a minimum amount each year. Income earned in your RRIF is not taxed, but you pay tax on all the money you take out of it.
What is an RRIF?
6. Payout Annuities
Gains from registered annuities are tax-deferred, and you pay tax at your tax rate only on the payment you receive each year. You select your periodic payments when you purchase the annuity. In certain circumstances, non-registered annuities offer preferential tax treatment (prescribed annuity tax treatment).
What is an annuity?
