Some investors planning for retirement using exclusively registered accounts such as RRSPs and TFSAs, and/or contributing to a generous workplace pension plan (if they are lucky enough to have one) may not need to worry about managing capital gains or losses. In addition to registered accounts some investors may choose to use taxable accounts to save for retirement. Let’s look at some facts before my case study.
Some Capital Gains Facts
- A capital gain occurs when you make money from selling an investment for more than you paid for it.
- If you have capital gains for investments inside a Registered Retirement Savings Plan (RRSP), capital gains are not taxed until the money is withdrawn from the account, where at that point, the amount of the withdrawal is taxable income for that year.
- If you have capital gains for investments inside a Tax-Free Savings Account (TFSA), capital gains earned are not taxed. Generally, interest, dividends, or the aforementioned capital gains earned on investments inside a TFSA are not subject to tax-either while held inside the account or when money is withdrawn from the account; it’s a true tax shelter once monies are contributed to it. There are some situations however where tax is payable on TFSAs and you can read about that here.
- Unlike regular, employment income or interest earned from savings accounts or bonds, capital gains are not taxed at your full marginal rate. If fact, in taxable (non-registered accounts), capital gains are taxed quite favourably since you only pay gains when they are realized. When you decide to realize the gains you pay tax on 50% of the gains. A quick example: a $1,000 gain x 50% = $500 taxable at your marginal tax rate. You can find the marginal tax rates for individuals here.
Some Capital Losses Facts
- A capital loss is the loss you “realize” (that word again) when you sell an investment for less than you paid for it.
- A capital loss can be used to reduce capital gains incurred during the same tax year (actually, I believe capital losses must first be used to offset gains you’ve incurred in the current tax year).
- A capital loss can be used to reduce gains incurred to any of the preceding three (3) tax years, or can they can be banked for use against future capital gains.
- A capital loss typically cannot be used to reduce other income.
- Capital losses inside RRSPs or TFSAs are not deductible.
- Capital losses must be recorded (on the tax return) in the year they are realized.
My Case Study
You may recall I wrote about this stock and wondered what the heck I should do with it. Well, I decided to sell it this fall and “realize” a capital loss in doing so. Because this stock was in a taxable account I could realize the loss now since I expect to pay some capital gains on some investments in future tax years. I think this was a good call but I suppose I’m biased, otherwise I wouldn’t have done it. I decided to cut the loser, pick myself off the ground and move on. What did I do with the funds? Nothing for now. Did I make the right move? What do you think?
The punchline: as part of your year-end financial planning consider selling some duds in your portfolio to realize capital losses to offset capital gains. There are more ins-and-outs with respect to capital gains and losses but I hope this post shed some light on this issue.