Optimizing the taxation of your investment income

Sébastien: Welcome to iA Financial Group’s “In Your Interest!” podcast. This week our friend Ashleay is on vacation; so it’s me, Sébastien Mc Mahon, who will have the chance to chat with Pablo Carrera, Regional Sales Director. So hello, Pablo.

Pablo: Hello! Thank you for having me back. Always a pleasure to be here.

Sébastien: It’s always great to spend some time with you, my friend. This week, we’ll be talking about something that may be a little technical, not something I’d call “light summer reading,” I would say. But it’s still important enough to make a large difference in your portfolio. Today we’ll be discussing the taxation of investments.

Pablo: Yes.

Sébastien: All right. So, the taxation of investments can be complicated. But how do you find your way around?

Pablo: So, you’re right: it can be a complicated topic. Well, yes and no—and, again, I’m not trying to hide behind the question. In reality, there are details that become important, but we will turn to experts and resources to get through them. But in the general sense, taxation is not an overly complicated subject. Let’s start from the beginning. So any gains, income, profits—call them what you like—that you generate with investments outside of registered plans are taxable (so obviously we’re excluding RRSPs, TFSAs, FHSAs—a new program—and RESPs). And depending on how the profit is generated, what source of income we’re talking about, there are different tax rules. So, if you generate interest, that’s one level of taxation; if you generate dividends, it’s a different one; capital gains, again, different.

Sébastien: Okay. And the latest federal budget—the 2024 federal budget—changed a few things. Could you go over those changes and why they’re important?

Pablo: Yes, absolutely. In the latest federal budget, the government decided to change the inclusion rate for the taxation of capital gains. So, prior to that change, you had to include half of every dollar of capital gains as taxable income: so, for every $1.00, $0.50 was taxable, $0.50 went into your pocket tax free. This year, the government decided to increase the inclusion rate from 50% to two thirds (or approximately 66.67%) for all companies, for all trusts and also for individuals. Having said that, individuals do benefit from an exemption on the first $250,000 of capital gains generated every year. So the first $250,000 still gets taxed at the old inclusion rate of 50%, and starting from $250,001, the inclusion rate for individuals jumps to two thirds.

Sébastien: Okay. So, you would need sizable investment gains in any particular year to be affected by this change, such as the profits of selling a secondary home or if you have a sizable portfolio.

Pablo: Absolutely, yes. And that’s an important point, because when we read about these changes, we think: “how is this going to affect me? Am I going to have to pay more taxes?” The reality is, for most people, unless you have a substantial investment portfolio in non-registered assets—and when I say a substantial portfolio, I’m talking more along the lines of over $3.5-$4 million of non-registered money—then, yes, you could expect to generate over $250,000 in capital gains every year. But, for most people, this may not be such a big change in their tax bill at the end of the year.

Sébastien: Okay. But everything that has to do with taxation is very important in terms of planning long-term goals. And it’s also very important in the relationship that you have with your advisors. You and I both know many advisors, and we know that the best ones are very active in advising their clients not just on investments and savings, but on everything that has to do with taxation.

Pablo: That is so true. And, in fact, to take it a step further, we strive so much, we work so hard to generate those profits, gains, returns; we’re always running after them, trying to predict what the market will do and all that. Let’s start from the point that the market is unpredictable, that’s where we’ll begin: once you’re invested in the market, there is no way to know where an investment will go, what the market will deliver—unless obviously it’s a guaranteed investment, which is a separate story. Having said that, we oftentimes forget that what’s really important is how much money you keep after paying your taxes. So, the taxation part of it is something that we can actually control with proper planning, with a good financial advisor. And that’s where we can really add some value. Because while going after returns is great, you can’t forget that once you’ve generated those returns, you have to pay taxes on them. What’s really important is the amount of gains that you keep in your pocket.

Sébastien: And it’s not a one-off thing. You need to have a strategy that regularly ensures that you’re making the most of what’s out there and are getting as much as you can out of your gains over the course of your life.

Pablo: And this is where a good financial advisor becomes really, really handy. Because this is something that you build throughout the relationship with your advisor. It’s not a one-off situation, like you said, where you’ll look at and try to optimize your taxation this year and then next year you won’t look at it again, just assuming that it’s going to be the same. No, you have to go back every single year. Sometimes, maybe even around this time of the year, around the end of the year, when you’re looking at what you can do, the potential strategies that can be put in place at the end of the year to optimize, to take your taxable situation and improve it slightly, so that you end the year on a good note.

Sébastien: And to achieve that, of course, we’re talking about the best practices in how to use RRSPs, TFSAs, FHSAs, RESPs. This is where those opportunities come into play.

Pablo: Absolutely, yes. And in fact, you named some of the great tools that we have available to put those tax-saving strategies in place. Sometimes we have this impression or this notion that an RRSP is not a positive thing because, “You know what? I’m going to save some money now, but the government will hit me at the turn and I’m going to have to pay more taxes later.” If we have a good coach, if we have a good advisor who understands our situation and who understands our objectives, we can use those tools, those types of accounts, to really optimize our entire—our global—investment strategy.

Sébastien: Okay. And maybe another angle here. A question I get asked a lot—and I don’t know how to answer this, so I’m glad to have you here—is that clients will sometimes receive tax slips and even have to pay taxes when their funds show negative returns. And we know that the fund can have negative returns because the market is down, a manager can have a bad year, many things can happen. Can you just explain how someone can hold the fund, see the fund losing value at the end of the year and still have taxable income at the end of that year?

Pablo: Absolutely, yes. This is actually a great question, and it does come up quite a bit. I have investments, I get a tax slip at the end of the year to pay taxes on the gains, and I see my investment statement shows negative returns. How can that be? To start off, we need to understand that, when you have managed money—whether it be in mutual funds, segregated funds—so whenever you’re trusting a fund manager to manage the money for you, you’re paying them for that service. That manager will make transactions within the fund over the course of the year: purchases, sales, maybe earned dividends or earned interest through those investments. All those gains are also taxable, and the tax on those gains, well that’s the responsibility of the unit holders. So, during the course of the year, the fund manager at their level can generate taxable gains or taxable losses and, at a parallel or a secondary level, the investor themself can sell their investments and they can generate some capital gains or losses when they sell their investments. What we really need to understand is that there are two levels of taxation when you hold funds. Now, it’s also important to realize that those two levels are not overlapping. In other words, you’re not going to double dip and pay taxes twice on the same money. But—without getting into the weeds—the idea here is you need to understand that you can have taxable gains, dividends, or interest generated within the fund, even if on January 1 the fund had a price or a net asset value of $10 and then decreased over the course of the year to end up at $9.75 on December 31. While you’re going to show a negative return on your statement, if that fund held some bonds, for example, those bonds may have paid interest over the course of the year, and you will get a tax slip for your portion of the interest on those bonds.

Sébastien: And this is all for non-registered, correct?

Pablo: Absolutely, yes. We’re only looking at non-registered money. We are excluding from the conversation everything that’s in an RRSP, TFSA, FHSA, RESP, all those tax-sheltered types of accounts.

Sébastien: Similar situation: let’s say you have a non-registered account that you manage yourself. You have two stocks. One is a very small position and one a very large one. The large one loses money, but you don’t sell at the end of the year, so nothing happens fiscally. Let’s say the small position you have doubles. You sell it, you have a capital gain. Overall, you’re less well off than at the beginning of the year, but you still have to pay taxes on the gains that you made on your small position. Kind of a similar situation?

Pablo: Yes. Absolutely. Yes.

Sébastien: Okay, right. So yeah, I’m even more convinced that managing the tax burden on an investment portfolio can have a significant positive impact on the growth of your wealth. Thank you for clarifying this, Pablo.

Pablo: I hope I was able to help. Thank you very much for having me.

Sébastien: All right. So, this concludes this week’s episode. Thanks again for enlightening us on investment, taxation and the changes in the 2024 federal budget that, if we all remember, was a big thing in the spring when it came out. A big thank you to all listeners; we’ll talk again next week. Loved this podcast? Want to know more about economic news? Follow our “In Your Interest!” podcast, available on all platforms, visit the economic news page on ia.ca or follow us on social media.