Canada Revenue Agency 101: 3 Legal Ways to Lower Your Taxes

One great, legal way to lower your taxes is to hold dividend stocks like Enbridge Inc (TSX:ENB)(NYSE:ENB) instead of bonds

| More on:

Tax efficiency is one of the most important — yet overlooked — aspects of investing. You can never be sure that you’ll get a great return on stocks. But getting the lowest tax rate possible is entirely within your power.

The Government of Canada provides a number of tax-free and tax-deferred accounts that allow you to lower your tax rate. The most notable of these are Tax-Free Savings Accounts (TFSAs) and Registered Retirement Savings Accounts (RRSPs). By holding your investments in these accounts, you can legally lower your tax rate over the course of your working life.

In addition, there are ways to lower your taxes even outside of registered accounts. As you’re about to see, different types of investment income are treated differently under the Canadian tax code.

By buying the right asset categories, you can dramatically reduce your investment taxes even outside of your RRSP or TFSA. We can start by looking at one of the most obvious ways to do this.

Buy dividend stocks instead of bonds

Dividends generally get a much more favourable tax treatment than bond interest in Canada, as dividends have a tax credit applied to them, whereas interest does not.

As an example, consider an investor holding $100,000 worth of Enbridge Inc (TSX:ENB)(NYSE:ENB) stock. Enbridge is a dividend stock that yields about 6.2% at current prices. That means you get around $6,200 in pre-tax dividends a year from $100,000 worth of ENB stock.

To calculate your tax credit on those dividends, you “gross up” the $6,200 by 38%, giving you a figure of $8,556. You then apply a 15% credit to that amount, giving you a credit of $1,283.

Your ultimate tax on the dividends depends on your income level, but the dividend tax credit (on eligible dividends) always results in lower dividend taxes compared to interest taxes.

Max out your TFSA

Buying dividend stocks is a great way to minimize taxes outside of a tax-free savings account. Within a TFSA, on the other hand, you can hold whatever you want, so it goes without saying that you should maximize your TFSA balance, ideally reaching the maximum contribution room you’re entitled to.

Here, you can hold bonds without having to worry about the severe tax treatment they get outside of a registered account. You can also hold dividend stocks, growth stocks, and exchange-traded funds (ETFs) inside your TFSA, making it a flexible account to lower your tax rate no matter what you invest in.

Hold U.S. funds in your RRSP

A final and often overlooked way to reduce your tax rate is to hold U.S. funds of U.S. stocks in your RRSP. If you’re looking to get U.S. exposure in your RRSP, it’s always best to just buy the U.S.-listed fund rather than buy a Canadian equivalent, because Canadian-listed funds of U.S. stocks pay a withholding tax that your RRSP can’t save you from.

Buying the equivalent U.S. fund spares you this tax, making U.S. funds obvious choices for RRSPs.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Andrew Button has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Enbridge.

More on Dividend Stocks

exchange traded funds
Dividend Stocks

1 Top High-Yield Dividend ETF to Buy to Generate Passive Income

An ETF designed as a long-term foundational holding pays generous monthly dividends.

Read more »

Canadian Dollars bills
Dividend Stocks

Invest $10,000 in This Dividend Stock for $2,430.12 in Passive Income

This dividend stock has proven time and again it's a safe, reliable stock that still has the power to explode…

Read more »

A worker drinks out of a mug in an office.
Dividend Stocks

3 Canadian Dividend Stocks to Consider Adding to Your TFSA in 2025

If you're looking for long-term, undervalued dividend stocks to pick up in your TFSA, consider these first.

Read more »

Canadian dollars are printed
Dividend Stocks

Build a Cash-Gushing Passive-Income Portfolio With Just $25,000

An investment of $25,000 in these high-yield Canadian dividend stocks can help you earn $1,955 in tax-free passive income.

Read more »

dividends grow over time
Dividend Stocks

These Are the Top 4 Undervalued Stocks to Buy Right Now

These four undervalued stocks offer a change to get in on great value long term, with promising futures ahead.

Read more »

stock research, analyze data
Dividend Stocks

Where Will Canadian Tire Stock Be in 5 Years?

With Canadian Tire stock still trading roughly 20% off its all-time high, is it one of the best investments you…

Read more »

a man relaxes with his feet on a pile of books
Dividend Stocks

1 Superb Canadian Dividend Stock Down 17% to Buy in Bulk

This dividend stock is a standout option.

Read more »

The sun sets behind a power source
Dividend Stocks

Should You Buy Fortis While it’s Below $60?

Fortis is off the 12-month high. Is it time to buy?

Read more »