Tweak your asset location strategies
Adrian Mastracci, Senior Portfolio Manager at Lycos Asset Management
Investors need to understand which accounts are better suited to hold their investments. Three pools of capital typically suffice. Don’t just sprinkle investments you buy into any random account on hand. Instead, I recommend an organization that has a purpose for your investments.
It is part of income tax planning called “asset location.” Start by prioritizing decisions relating to your asset location.
Here is my simple approach:
- Relate asset location decisions to the types of investment income you expect.
- Investments produce combinations of interest, rental, dividend, gain, and loss income.
- One objective of your location combination is to pay the least tax.
- Using a blend of three different investing pools provides flexibility.
These three pools of capital implement your asset location strategy:
1. Taxable Accounts
They are mainly cash and margin accounts owned personally, by a company or a trust. Investments, such as stocks and ETFs, are best held in these accounts for tax efficiency. Canadian dividends, gains, and losses received in these accounts are better taxed than interest. However, the account owner reports the taxable income every year as deferral is not available.
2. Tax-Deferred Accounts
Tax-deferred accounts include the RRSP, RRIF, and locked-in plans. Investment income earned in these accounts is tax-deferred until withdrawn. Where possible, interest-bearing investments are more suited for such accounts. All funds withdrawn from tax-deferred accounts are fully taxable, like salary. There is no preferential tax treatment of Canadian dividends, capital gains or losses. Note that dividend tax credits are lost as they cannot be used within these accounts.
3. Tax-Exempt Accounts
A TFSA is desirable as both the capital and investment earnings are tax-exempt on withdrawal. While contributions are not deductible, each spouse can arrange the maximum annual deposit. Hence, it makes sense to hold investments with capital gain potential in the TFSA. Dividend tax credits are also lost in TFSAs and capital losses don’t offset gains outside TFSAs. Unlike RRSP deposits that stop at age 71, TFSA deposits can be made for your lifetime.
Locating specific investments in all three pools provides flexibility in retirement. Decisions to draw retirement funds from all three pools can change every year.
Overall, asset location is an integral component that fits like a glove with your asset mix. It’s best to weave both strategies into your game plan at the same time.