Here’s a simple fact about growing your nest egg: making money is easy. Saving it can be the tricky part.
That’s why it’s important to consider how your investments outside your RRSPs are taxed. To illustrate, here are three general tax treatment examples for an individual with an annual income of $85,000 and earning $1,000 of investment income in three different types of investments (This example uses the 2022 Ontario average tax rate of 29.2% and 31.5% marginal tax rate. Source: https://ca.talent.com/tax-calculator):
If you earned $1,000 in interest income from a bond or GIC, you have received the most tax inefficient income. At tax filing time, this full amount would be taxed at your marginal tax rate. The taxes on your interest will be calculated like this:
- $1,000 x 31.5% marginal income tax rate = $315
- So, 1,000 – 315 = $685 in your pocket after tax
Dividend income receives a favourable tax treatment. The reason for this is because it represents after-tax corporate profits which are distributed to shareholders. There are two separate calculations to determine your tax payable on dividends. (Source: https://turbotax.intuit.ca/tips/the-federal-dividend-tax-credit-in-canada-332)
- If you earned $1,000 in corporate dividends, you would first need to multiply it by the Gross-up rate of 38% (which is the same across Canada)
$1,000 x 1.38 = $1380
- Next, calculate the dividend tax credit. The current rate is 15.0198% for eligible dividends.
$1380 x .150198 = $207.27
- The $207.27 dividend tax credit would reduce your taxable rate to $1172.73; multiplied by your marginal tax rate, you would have $803.32 after tax
Most people are familiar with the investment rule of buy low/sell high. The goal of selling high is to make a profit, otherwise known as a capital gain. For instance, if you bought some stock and made a $1,000 profit, your capital gain would be $1,000. The Canadian system only requires you to pay tax on half (50%) of the gain. (Source: https://www.moneysense.ca/save/taxes/capital-gains-tax-explained/). So, your $1,000 gain becomes $500 for tax reporting purposes:
- $500 x 31.5% marginal tax rate = $157.05
- Therefore, $1,000-157.05 leaves you with $842.95 after tax
- This amounts to an extra $157.05 compared to interest income and an extra $39.63 compared to dividend income