The best possible after-tax return can be achieved by balancing not only an investment's risk in relation to potential return but its risk in relation to its after-tax return. Incorporating tax effective strategies when choosing your investments may help you reduce or defer the amount of tax incurred. Your advisor can help you understand the tax implications of investing so you can take advantage of the most tax effective ways to meet your objectives.
If you hold mutual funds outside of a registered plan, keep in mind that all income earned by these investments is subject to tax. However, not all investment income is taxed equally.
The Most Common Types of Mutual Fund Distributions
| Types of Distribution | Description | Tax Treatment | Examples |
|---|---|---|---|
| Interest | Earned on investments such as treasury bills and bonds | Fully taxable at the same marginal tax rate as employment income | |
| Canadian Dividends | Occurs when funds invest in shares of Canadian public corporations that pay dividends | Preferential tax treatment for individuals through the dividend tax credit | |
| Capital Gains | Realized when an investment within the fund is sold for more than its original price | Preferential tax treatment, as only 50% of a capital gain is taxable | |
| Foreign Non-business Income | Earned when the fund received dividends from, or interest on, non-Canadian investments | Fully taxable at the same marginal rate as employment income | |
| Return of Capital | Occurs when a fund’s objective is to pay unitholders a regular monthly distribution, but interest, dividends and realized capital gains are less than the fixed distribution amount | Not taxable in the year received, but reduces the Adjusted Cost Base (ACB), which generally results in a larger capital gain when the investment is sold |
Putting Everything in the Right Place
Based on the different tax treatments of investment income, you may wish to consider strategies that maximize tax efficiency within your portfolio. One option is to hold investments that earn interest income within your registered plan, where income is tax-sheltered, and investments with preferential tax treatment in a non-registered account. Speak to your advisor about other tax-efficient strategies for your portfolio.
Taxes and Investing in Mutual Funds
Understanding how your investments are taxed is an important part of developing an effective investment plan. Our brochure Taxes and Investing in Mutual Funds provides general tax information related to the purchase and sale of mutual fund investments in a non-registered account, with a specific focus on how mutual fund distributions are taxed.
With greater knowledge, you can become a more informed consumer and make better investment decisions.
