Jeffrey Ray, Assistant Vice President, Mutual Funds and Structured Products, Manulife Investments
Income from non-registered investments is typically taxable in the year it is earned, and the tax treatment depends on whether the investments produce capital gains, dividends or interest income. Should tax implications sway how investors treat their non-registered investments? Only to a point, says Jeff Ray, Assistant Vice President, Mutual Funds and Structured Products at Manulife Investments in Toronto. "Take taxes into account, but don't let that cloud a good investment decision." Once investors have made their investment decision, they should be aware of methods that can help with taxes, he says.
Mr. Ray has spent over 18 years in financial services, including mutual funds, direct banking and insurance, and has developed and managed investment products.
Q: Different types of investments are taxed differently. What are the best and worst, purely looking at the tax treatment?
Jeff: Interest income is fully taxable at an individual's personal marginal income tax rate. Under current tax laws, only 50 per cent of capital gains is taxable as income at your personal marginal tax rate. Dividends from Canadian sources, which are taxed at a grossed-up amount and subject to a dividend tax credit, are more tax-efficient than interest income.
Q: Should you try to achieve a balance in your portfolio based on tax treatment?
Jeff: It's hard to say that there's a right balance. Any fixed income investments, like a bond or GIC, earns interest income, so that's the worst-case scenario from a tax perspective. There's no real way to avoid that. If you look at equities, there are companies that don't issue dividends, so you won't get a tax bill on an annual basis. But maybe you should consider being in bonds instead of equities. Equities might not be the best for you.
Q: What are the main options to reduce the tax hit?
Jeff: There are account structures such as the TSFA [Tax-Free Savings Account] that are tax exempt. For your non-registered investments, investment products such as corporate class mutual funds are designed to be more tax-efficient allowing potential tax-deferral of capital gains as well as distribution of tax-efficient income.
Q: The federal government introduced the TFSAs in 2009, but a recent survey found that half of Canadians know little about them. Another 13 per cent don't even know what a TFSA is. How important is this opportunity?
Jeff: You currently can contribute up to $5,000 a year (plus any unused contribution room) in different types of investments including securities of a mutual fund. What grows in the TFSA is tax-free, and when you withdraw it you're not paying taxes, either. The only other place you can grow your money tax-free, if you think about it, is your own home if you sell it at a gain. So use the solutions available to you. If you have both unused TFSA and RRSP contribution rooms and do not have sufficient funds to contribute to both types of plan, it is recommended that you consult a tax or financial advisor as it may be more beneficial to contribute to one account type over the other depending on your circumstances.
Q: There's a lot to weigh, for your investment position and tax position.
Jeff: This is where financial advice comes into play. It is always prudent to talk to your tax or financial advisor. They can help you look at your plan, but you need to let them know the details about your financial situation. They need to see the big picture.
Q: Taxes can also be an issue when you're selling. Should that be a secondary consideration then, too?
Jeff: Always consider all the relevant factors. It may not be in your best interest to sell when you've had a huge gain, just because you'll have to pay taxes on it. It may lead to decisions you shouldn't be making. Now, if you've had a loss, sometimes it's a good tax strategy to offset that with a gain. Taxes alone shouldn't drive the decision but it should complement it.
Q: Mutual funds have a trust structure and a corporate class structure. Why is the corporate class advantageous?
Jeff: With the trust structure, each fund is a separate legal and tax entity. Whatever taxable income the fund earns that year is distributed to the security holders; you may get a T3 tax slip, and you may have to pay taxes if you hold the investment in a non-registered account. The trust structure wasn't designed for tax efficiency of non- registered account holders in mind. But under a corporate class structure, the corporation is the legal and tax entity, and has a number of funds. You can switch between funds within the corporate structure without triggering a taxable disposition and therefore, you can potentially defer taxes on capital gains that you would otherwise realize under a trust structure. Also, the corporate structure generally distributes less (or no) year-end capital gains relative to the trust structure because of its ability to use losses from all the funds under the same tax entity.