When I first took the LLQP a long time ago (and I mean a long time… like when I was in my 20s and there was no white hair… ) I was introduced to the calculation of the dividend tax credit. Little did I know the significant difference between interest, dividends and capital gains because when you’re a green pea and there’s so much information flying at you, it’s hard to discern the difference.
In this infographic, we outline the difference between:
- Type of investments available
- Investment strategies
- Tax treatment
I’d like to provide background behind the investment strategies portion.
The interest section states “RRSP, RESP, RRIF offer tax advantages. You don’t pay tax on what you earn until you withdraw.” The logic behind this is because the inclusion rate is 100% and taxed in the year it’s accrued or received, therefore you should take advantage of the sheltered growth inside a registered account and then pay tax on withdrawal. The same logic can be applied to RDSP and TFSA. (Please note in TFSA, there’s no tax on withdrawals.)
When investing in a non-registered environment, dividends make sense because of its favorable tax treatment due to the gross up and dividend tax credit (but remember tax is paid on dividends in the year they are received or accrued). At retirement time however, dividends can trigger the OAS clawback because of the inclusion of the grossed up dividend amount included in line 234. (This can also affect the age amount tax credit too and clawback of EI benefits.)
Lastly, for capital gains, because the inclusion rate is 50%, it’s sensible to consider investing in a non-registered environment too. The other plus with a capital gains is you only pay tax on the year that you sell your capital gain, therefore you can be strategic with the timing of the sale of your investment.
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