What’s the single biggest factor in determining how much you ultimately earn from your investments?
If you guessed “tax burden,” you’d be right. While you have the ability to boost your pre-tax returns by investing intelligently, a high tax rate will take considerable percentages of your gains away from you.
In order to maximize your take-home returns, you need to minimize your taxes. With that in mind, here are three little-known “hidden” Canada Revenue Agency (CRA) taxes that can eat into your returns — and how to avoid them.
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RRSP withholding taxes
You probably know that Registered Retirement Savings Plan (RRSP) funds are taxable on withdrawal and that RRSP taxes can be heavy if you withdraw before your taxes presumably decline in retirement. These facts are common knowledge. What’s less well-known is that RRSP withdrawals are subject to withholding taxes.
Withholding taxes are taken out when you withdraw from your RRSP early. The amounts are usually taken out automatically by your financial institution, so you have no say in the initial withdrawal. The withholding tax amounts are as follows:
- 10% on withdrawals up to $5,000.
- 20% on withdrawals between $5,000 and $15,000.
- 30% on withdrawals of more than $15,000.
Because your financial institution takes these amounts out of your account automatically, you’ll have to pay them even if your marginal tax rate is lower than the withheld amount. For example, if a $15,001 RRSP withdrawal is your only income for a given year, then your tax rate is probably much lower than 30%. However, the amount taken out is 30% anyway; if you earn no other income, you’ll get most of it back the following year in a tax refund.
Extra taxes on U.S. dividend stocks
Not so much a “CRA tax” as an IRS tax, U.S. dividend withholding taxes are amounts that you, as a Canadian, have to pay to Uncle Sam!
This tax is pretty straightforward: for any dividend you receive from a U.S. company, you pay a 15% withholding tax. The tax situation might be different if you are a dual citizen, but different does not necessarily mean simpler: the U.S. goes after its citizens for income taxes no matter where in the world they live. So, if you’re Canadian and 15% is the only tax you have to pay on U.S.-sourced income, consider yourself lucky.
TFSA account violation taxes
Last but not least, the CRA assesses taxes on people who violate their Tax-Free Savings Account (TFSA) account rules. Taxable violations include the following:
- Contributing past your limit (incurs a 1% monthly tax).
- Holding shares in a company you control in your TFSA.
- Day-trading full-time in your TFSA.
Of all of these TFSA taxes, the day trading tax is by far the most controversial. You can avoid it by holding quality blue-chip stocks long term, instead of day-trading speculative securities.
Consider Royal Bank of Canada (TSX:RY), for example. It’s a Canadian bank stock that pays a 4%-yielding dividend and has very strong liquidity and capital ratios. It is a sensible financial institution whose shareholders have been rewarded over the long term.
At today’s prices, Royal Bank stock is fairly cheap, trading at about 14 times earnings. That’s much cheaper than the TSX Composite Index, though a little pricey for the banking sector. Royal Bank stock is worth paying a premium price for. It has moderate growth and a reputation for stability. More than 150 years old, the bank survived the great depression, the 2008 financial crisis, and the 2023 banking crisis. It’s a very well-run financial institution.
