Do you know how your investments are taxed?

Deciding where to put your investment dollars can be a complicated task. It depends on a number of factors, including your goals, your age and the risk you want to assume. And while many look for the highest rate of return, or yield, they think they can get, there are a couple of other factors to consider.

Chasing just high yield can carry risks — as witnessed by the number of investment bubbles that have burst over the past few years.

But another consideration is that different investments are taxed differently, with the result that some have more favourable tax treatment than others.

“When you buy investments, it is always important to consider the total return, not just the yield,” says Ed Rempel, a certified financial planner with Ed Rempel & Associates, part of Armstrong & Quaile Associates Inc.

Understanding the different tax treatments is important when considering investments outside a registered retirement savings plan (RRSP) or a tax-free savings account (TFSA). (Investments in an RRSP are tax-sheltered until withdrawn, while all income earned within and withdrawals from a TFSA are generally tax-free.)

The examples below are from Ontario; tax rates vary from province to province.

There are three main kinds of investment income:

1. Interest income

This comes from investments such as high-interest savings accounts or guaranteed investment certificates. Of the three kinds of investment income, interest is taxed at the highest rate. Let’s say your total income is $65,000 -- that puts you in the 29.65% tax bracket (2024 rates, as of January 15, 2024). If you earn $10,000 in interest income, you’ll end up keeping $7,035 of it after paying income taxes.

2. Dividend income

Dividends are basically profits you receive from your stock, or share, of ownership in a company or through an equity mutual fund. As a Canadian taxpayer you can claim a “dividend tax credit” that will lower the amount of tax paid on eligible dividends from Canadian companies. Canadian dividends are taxed at a lower rate than interest income. So, again, let’s say you fall into the 29.65% tax bracket, and you earned $10,000 in dividend income (eligible dividends are taxed at a marginal rate of 7.56%). You would end up keeping $9,244 of that after taxes. (The tax rate assumes no other income than dividend income and ignores the potential for having to pay alternate minimum tax.)

3. Capital gains (or losses)

This is the difference between what you originally paid for an asset, such as a stock or property, and what you sold it for, calculated at the time of sale, less expenses in acquiring and selling the asset. It doesn't apply to your primary residence, but can apply to a second home such as a cottage, or to an investment property. As an example, someone in the 29.65% tax bracket who earned $10,000 in capital gains would get to keep $8,518 of that, once all the taxes were paid.

As an aside, income tax is not the only tax that those investing in real property must deal with. Real property taxes must also be considered, as well as other taxes, such as:

• federal tax on real property if the owner is a non-resident,
• federal tax on real estate speculation,
• provincial and municipal taxes on vacant homes (depending on your province and/or municipality), and
• the proposed federal underused housing tax.

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