Wondering what the best investments for non-registered accounts in Canada are? This post is for you.
When making investment decisions, deciding on the right asset allocation is just a piece of the puzzle. The Investment account you choose is equally important. And so are the securities you invest in.
Focus on the first part alone, and you may end up paying too much in taxes on your investment returns.
In this post, you’ll learn:
- The key differences between registered and non-registered accounts;
- Different investment returns and their tax effect; and
- The best investments to hold in non-registered investment accounts
What are Non-Registered accounts?
Registered accounts are a special type of investment accounts that lets you grow your investments on a tax-deferred or tax-free basis. You’ll generally avoid paying taxes on the returns as along as your money remains in the account.
On the other hand, non-registered accounts allow Canadians to save and invest their money but without the same tax-sheltered investment growth they’ve come to associate with registered accounts like RRSP, TFSA, RESP and so on.
This means any investment income earned in a non-registered account, including dividends, interest and realized capital gains, will be taxed in the same year.
Differences between registered and non-registered accounts
One obvious difference between a registered account and a non-registered account is the tax advantage. But there are other key differences you should know about.
Each one is explained below:
- Tax advantage: Registered accounts let your investment returns grow tax-free
- Flexibility: Non-registered accounts are generally more flexible since there are no contributions or withdrawal limits. You can invest as much or as little as you want in the accounts, and withdraw any time you need the cash.
- Qualified Investments: CRA has a list of qualified investments for registered accounts. This won’t be an issue for most investors but it’s still a good idea to understand what you’re allowed to hold in a registered account. For example, you can only invest your registered account funds in securities that are listed on a designated stock exchange. The same restriction isn’t applicable for non-registered accounts.
- Portfolio maintenance: To properly calculate the taxes due on your non-registered portfolio, you must keep track of your capital gains or losses, purchase prices to determine your adjusted cost base (ACB) and the selling prices. Things could get really complicated if you hold many stocks across different accounts. With registered accounts, the extra stress isn’t necessary.
- Tax rules for different asset types: Some investment types enjoy a more favourable tax treatment when held in a non-registered account. We’ll look at the difference in details in the next section.
Investment Types and their tax effect
The tax effect of each asset class depends on the type of returns you receive and the account you’re investing in.
GICs, Bonds and other interest paying assets
Interest income from bonds, treasury bills, GICs and other interest-bearing securities are fully taxable. This means they have the least tax advantage when held in a non-registered investment account.
And this is why you would generally want to hold them in registered accounts where the returns can grow and compound tax-free.
Canadian Equities (Stocks, ETFs, Mutual Funds)
In general, there are 2 types of returns you can expect on your equity investments
You’re entitled to dividend tax credit for dividends earned in a non-registered account. But the tax credit isn’t available for registered accounts.
The calculation is a little complicated but these are the steps:
- Gross up the dividends by 38%
- Calculate the tax due on the grossed up amount at your marginal tax rate
- Reduce the tax liability by the dividend tax credit (federal and provincial)
You can check this post for an illustration of how dividends are taxed.
The gross-up and the tax credit are necessary to prevent double-taxation. What does this mean?
Simply put, the dividends you received from Canadian corporations are after-tax earnings. The company already paid taxes on the income, so it isn’t fair to tax them again in your hands.
The dividend tax credit is CRA’s way of refunding the corporate tax the companies already paid on their earnings.
Capital gains or losses
Like dividends, capital gains have favourable tax treatments in non-registered accounts, but not in registered accounts. Only 50% of the gains are taxable.
For example, if the an investor bought a stock for $10,000 but sold it at $12,000 to realize a capital gain of $2,000, only half of the gains will be taxed.
With a marginal tax rate of 50%, the tax payable would be $500.
Tax due = 50% of Capital Gain * Tax rate
What if he sold at a loss?
There’s still a tax advantage! Capital losses on a stock can be offset against other capital gains. And if the losses exceed the gains, you have the option to carry back the losses to offset gains from the past 3 tax years or carried forward indefinitely.
The tax treatment of the returns from foreign equities also differs depending on the type.
Unlike Canadian equities with eligible dividends, you won’t get a dividend tax credit if you received dividends on your foreign equity portfolio. The dividend is fully taxed.
Also, the dividends you received could be subject to withholding tax in the foreign country. For example, a 15% withholding tax is applied on your dividends from U.S. companies. The only exception is if you hold the stocks directly in your RRSP or RRIF account.
You can claim a foreign tax credit if you’re investing through a non-registered account. For other registered accounts like TFSA and RESP, the foreign tax paid can not be recouped.
|Account Type||US Withholding Tax||Foreign Tax Credit|
|Other Registered Accounts (TFSA, RESP)||Yes||No|
Capital gains or losses
Capital gains on foreign securities, such as U.S. stocks, also receive a preferential tax treatment like their Canadian counterparts. Only 50% of the capital gains will be taxed.
Best investments for non-registered accounts
In other words, what are the types of investment that will receive favourable tax treatments in a non-registered portfolio?
A simple rule is to hold asset types with the most tax-efficient returns in a non-registered account. These includes:
- Canadian equities: Both the dividends and capital gains (or even capital losses) on your investment will enjoy favourable tax treatment.
- Foreign equities: Same as above. While the dividends on foreign equities may be subject to foreign withholding taxes, the foreign tax credit can offset some of the tax.
And if you’re wondering what the best ETFs for non-registered accounts are, the same principle applies.
In general, you should hold Canadian equity ETFs in your non-registered account and invest in a bond ETF using your registered accounts.
But given the current low yield on fixed-income securities, you start to wonder if investing in bonds is a good use of the contribution room in your registered accounts.
Other things to consider with non-registered accounts
When investing in a non-registered account in Canada, here are some other things you need to consider
You’ll trigger a capital gain or loss when you sell an investment in your non-registered account. And you need to include the gain or loss when filing your taxes for the year.
That means, you have to keep records of your selling prices to accurately calculate your gains and compute the taxes payable.
With registered accounts, selling an investment won’t result in a capital gain or loss. As long as the investments are left in the accounts, you won’t have to worry about filing taxes on the gains.
Withdrawing from the account
One of the advantages of investing using a non-registered account is the flexibility.
You can withdraw from the account any time you like without worrying about breaking some rules. And re-contribute the money the next day if you have to.
Registered accounts are not this flexible. Even where there are no restrictions on when you can withdraw, like in a TFSA, you still have to wait till the next year to recontribute the money.
How to open a non-registered account
In requirements may vary from one financial institution to another, but you’ll need to provide your SIN and a valid means of identification.
The SIN is required to properly track and document your transactions and to generate the relevant tax forms at the end of the year for tax filing purposes.
When to use a non-registered account
Why would anyone want to use a non-registered account when a registered account allows tax-free compounding of income?
Here are a few situations where using a non-registered account makes sense
- You have maxed out your registered accounts.
- You want to invest using a margin account
- You don’t want to be restricted to just the qualified investments permitted in registered accounts.
Tips for investing in non-registered accounts
Since the on-going maintenance and recordkeeping of a non-registered portfolio can be time-consuming, it is very important to keep things simple. These can mean
- Not opening more than one account. Look for a brokerage that meets most of your requirements and stick with it. Tracking the adjusted cost base of a security is stressful enough, you don’t want the extra headache of tracking it across many brokerages.
- Limit the number of securities you hold. If possible, only invest using one of the all-in-one ETFs
- Avoid foreign listed ETFs. If you hold U.S. listed ETFs for example, you have to track the ACB in Canadian dollars. An extra stress for your portfolio.
Related Post: Asset Allocation ETFs: How Do They Work?
Yes, they are. However, you can minimize the taxes by setting up your portfolio to generate tax-advantaged investment returns like dividends and capital gains.
It depends. The actual tax will vary from one investor to another. The key factors are your marginal tax bracket (determined by your income), the type of investments you own and the accounts you use (registered or non-registered).
In general, you should hold Canadian equities to minimize your tax liability. Income earned from bonds or other interest bearing investments will be fully taxed in a non-registered account.
When possible, you should choose investments that minimize how much tax you’ll have to pay on your investment returns.
Usually, this means investing in a registered account. But this is not always possible.
So the best investments for non-registered accounts are the ones that help you keep your taxes low.