The New Democratic Party fired the first campaign shot at Canadian investment portfolios this week; aiming squarely at the capital gains tax. As part of its 2021 election platform, the NDP said it will raise the taxable portion of gains when equities are sold to 75 per cent from 50 per cent.
You might think that’s typical for Canada’s left-leaning party but history shows the Liberals and Conservatives have imposed or boosted the capital gains tax to generate revenue.
It’s an easy political target considering it impacts wealthy and institutional investors more than the average investor who saves for retirement through registered retirement savings plans (RRSP) and tax-free savings accounts (TFSA), where the capital gains tax does not apply.
That’s not to say non-registered capital gains are not part of a typical retirement portfolio. In many cases it’s the only tax-efficient alternative for investors who have contributed the maximum amount to their TFSA or the savings in their RRSP have grown to the point where withdrawals will need to be made at high marginal tax rates.
In most cases, investing in a non-registered account is also the only alternative for employees who accumulate shares in their own company through workplace share programs.
The company will often match the number of shares purchased. Over the course of decades those shares can accumulate to the point where the employee has a significant capital gains tax bill when they cash out - a bill that will get significantly higher if the capital gains tax is increased.
If you have non-registered equity investments, there are a few options to head off a potential increase in the capital gains tax. One is to sell now and pay the 50 per cent inclusion rate. Any tax expert will tell you to never buy or sell a stock entirely for tax reasons, but the ongoing bull market could make it the ideal time to trim profits.
If you are in a company share program that includes matching contributions from your employer, be sure to check the withdrawal conditions with the plan administrator. In many cases, a certain amount of time must elapse before the shares that the company contributes are vested to you. Selling too soon could send those shares right back to the company. If the period for the shares to be vested is two years, for example, you would be free to sell shares you purchased and shares the company contributed beyond the two-year period.
If you decide to sell your non-registered equities and pay the capital gains tax but still want the money invested in your retirement portfolio, the best home for it is your TFSA. From that point on capital gains are never taxed.
You first need to ensure you have the contribution room in your TFSA. For anyone who was 18 or older in 2009, the total contribution limit is currently $75,500. In 2021 it was raised by $6,000 and it is expected to be raised by at least another $6,000 next year - depending on the government in power.
Another option is to contribute the cash to your RRSP if you have the allowable contribution room. Those contributions can be deducted from your current taxable income and can be spread out over several years. They can also grow tax-free in investments until you retire.
There is a catch though; those contributions and any gains they generate are fully taxed when withdrawn. In other words, the capital gains inclusion rate is 100 per cent in an RRSP. If your RRSP savings grow too much you will be forced to withdraw your money at a high marginal rate, and could even face Old Age Security claw backs if your income is too high.
If neither option works, you can cushion the capital gains tax blow by selling non-registered equity investments that have gone down in value and apply those capital losses against capital gains at any point in the future.
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