investment in taxable / tax-free accounts

4782 Views 4 Replies 5 Participants Last post by Sampson, Sep 21, 2009

CuriousReader

Discussion Starter · Sep 21, 2009

I've read a few articles on investment that always have suggestions on which kind of investments to be hold in which kind of accounts. But I often not clear on why.

Could someone help explain which kind of investment (equity, bond, ETFs, mutual funds, GICs, cash, etc) to be hold in which kind of account (normal account, TFSA, RRSP) and some reasoning on why?

Thanks a lot!

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FrugalTrader

· #2 · Sep 21, 2009

Here's a short article on portfolio allocation indicating my preferences in each account.

Where do we start?

Lets take a look at various investment instruments and their tax consequences:

* Canadian Dividends – Dividend tax credit makes Canadian dividend income very tax efficient in a taxable account.
* Foreign Dividends – In non-registered accounts, foreign dividends are taxed 100% at your marginal tax rate (ie. if you are in the 40% tax bracket, you will pay $40 in tax for every $100 interest). In TFSA’s, right now, it seems foreign dividends will face a withholding tax.
* Bonds/GICs/Money Market – In a taxable account, interest is taxed at 100%.
* Income Trusts – Income Trust distribution varies between capital gain, return of capital, interest and dividends. Due to the typically higher interest content, I keep my income trusts and REITs within a tax sheltered account like an RRSP or TFSA.

RRSP:

* Fixed Income/Bonds/GIC’s
* Foreign Equities
* Income Trusts
* REITs

TFSA

* Fixed Income/Bonds/GIC’s
* Income Trusts
* REITs

Non-Registered:

* Canadian equities

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steve41

· #3 · Sep 21, 2009 (Edited)

Here is a simple example (the math isn't simple, BTW).

Imagine your investment entities were all of an identical growth rate. Furthermore, imagine your future comprised a traditional... 'working til retirement', 'saving for retirement', 'living off savings at a constant inflation adjusted (after tax) lifestyle', and finally, that our taxation and entitlement (CPP, OAS, GIS, clawbacks..) environment remained constant.

The latter item assumes that tax brackets, CPP/OAS, clawback thresholds, etc are indexed to inflation.

When you run a plan under those assumptions, it will almost always turn out that the RRSP strategy outperforms the TFSA strategy (albeit slightly). Now, since the TFSA has no taxation component, then it stands to reason that the RRSP will outperform a nonregistered investment with any mix of dividend, capital gains or interest.

The caveat is your estate plan. In some cases, choosing a non-rrsp investment will turn a better outcome (to your estate) if you die much earlier than you had planned. If think you might not make it out to a ripe old age, you might want to look to the TFSA or taxable investment.

Finally, the TFSA is useful if you anticipate needing a largish lump sum withdrawal for a major purchase.

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Rickson9

· #4 · Sep 21, 2009 (Edited)

CuriousReader said:
Could someone help explain which kind of investment (equity, bond, ETFs, mutual funds, GICs, cash, etc) to be hold in which kind of account (normal account, TFSA, RRSP) and some reasoning on why?

My wife and I hold stock in our non-registered, TFSA and RRSP accounts. Since we don't sell, we don't fully take advantage of the tax-free TFSA or the tax-deferred RRSP. An asset with a regular disbursement would benefit from being placed into one of these accounts (ie dividend paying stock, trust, GIC, etc.)

If a person isn't going to sell, the asset might as well be held in a non-registered account.

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Sampson

· #5 · Sep 21, 2009

Rickson9 said:
If a person isn't going to sell, the asset might as well be held in a non-registered account.

But it will be sold eventually - whether while you are living or not, so there may be a desire to optimize.

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