How to Avoid Capital Gains Tax on Your Retirement Portfolio – BNN Bloomberg
An increase in the inclusion rate of Canada’s capital gains tax came into effect on June 25. As the political fog clears, life goes on much as it always has for about 99.9 per cent of Canadians, according to the federal government. However, this number has been disputed by industry groups, medical professionals and farmers.
The rest, including corporate executives with stock plans, wealthy business owners, real estate speculators and anyone with an average income above $1.4 million, must now pay tax on two-thirds of any earnings above $250,000 a year instead of half.
Capital gains are calculated when an individual sells an asset such as a stock, property or business. The inclusion rate is the portion that is taxed at the depositor’s marginal rate.
For the average retirement investor with a good tax strategy, there are tools available to avoid paying capital gains tax at all costs.
Investments can grow tax-free in a TFSA
The most tax-efficient way to invest is through a tax-free savings account (TFSA), where capital gains — or any income — are never taxed.
The total TFSA contribution limit was expanded by $7,000 in January. 1. This means there is an additional $7,000 in contribution room for the vast majority of Canadians who have not contributed the maximum allowable amount in previous years. Amounts allowed are carried over each year.
The total contribution varies spatially for individuals based on contributions and withdrawals made over the years. To get an idea of how important the TFSA has become, the total amount allowed since it was introduced in 2009 is now $95,000.
Assuming Ottawa continues to expand the TFSA contribution limit, long-term investors will have a significant tax shelter to grow their savings.
Balance your TFSA with RRSP investments
Originally billed as a short-term savings tool for things like vacations or home renovations, the TFSA has grown into a retirement tax planning tool that can complement a Registered Retirement Savings Plan (RRSP).
Their differences are their strengths. RRSP contributions can be deducted from taxable income (unlike TFSAs) and grow tax-free, but those contributions and the returns they generate over time are fully taxed at the individual’s marginal rate when withdrawn.
With proper planning, RRSP withdrawals can be capped at the lowest marginal tax rate in retirement and topped up with tax-free money from a TFSA—significantly lowering your overall tax bill.
Both RRSPs and TFSAs can hold almost any type of investment, including stocks traded on major exchanges, bonds, mutual funds, or exchange-traded funds (ETFs).
It is important to note that investments in an unregistered account cannot be transferred to a registered account. Investors must first sell the investment and pay capital gains tax.
On the bright side, capital losses from the sale of shares in a non-registered account can be used to offset capital gains going back three years or any time in the future.
The case for investing in second properties is weaker
Capital gains from the sale of a primary residence are not taxed, making home ownership as tax efficient as a TFSA.
A capital gains tax, however, applies to the sale of any additional property, such as villas or rental properties. If the capital gain exceeds $250,000, the inclusion rate is now two-thirds.
An example of how the new rules could be applied by the Department of Finance says a high-income person in Ontario with a salary of $400,000 and a capital gain of $300,000 from the sale of a second property would pay 50 per cent of that profit, plus an additional two-thirds.
As a result, their tax bill will increase to $158,333. Under current rules, they would have paid only $150,000.
The higher capital gains inclusion rate is the latest in a series of federal government tightening measures on tax benefits for second properties.
Alternatively, investors looking to get diversified real estate exposure beyond their primary residence without tax implications have the option of purchasing real estate investment trusts (REITs) in their TFSA.
If you are fortunate enough to exceed your allowable RRSP and TFSA limits, you can still avoid paying capital gains tax by donating the capital gains spread to a registered charity.