How is investment income taxed in Canada?

There are tax considerations when you own investments. There may be tax owing when you sell investments. And different investment accounts have different tax implications when you take withdrawals.

Asking your financial advisor about taxes

I am sorry to hear your advisor has not been helpful, Louise. The financial industry has made it confusing for consumers, and most financial advisors do not really provide financial advice. They typically provide investment advice or insurance advice, generally focused on the products they are licensed to advise clients on, or that their company sells. As a result, their advice may be limited.

Many advisors have tax knowledge, and in some cases, they are quite knowledgeable. The advisor managing your investments may not have the answers to tax questions.

Owning and selling investments in Canada

How investments are taxed depends, in part, on what type of account they’re held in. 

• Tax-sheltered accounts like tax-free savings accounts (TFSAs) and registered retirement savings plans (RRSPs) can have tax implications on the income earned too—so they may not be fully tax-sheltered. More on this below.
• Non-tax-sheltered accounts require you to pay tax on the income earned. Your guaranteed investment certificate (GIC) could have tax payable on the interest income in a taxable non-registered account each year, Louise. GIC interest, even if it is compounded, must be accrued and reported for tax purposes at least annually. The same applies to stocks that pay dividends, or investments like mutual funds and exchange-traded funds (ETFs) that earn income from the underlying investments they hold.

When you sell an investment, tax only applies to taxable accounts. Capital gains or losses are irrelevant in a tax-free savings account (TFSA) and registered retirement savings plan (RRSP). But in a taxable account, selling an investment typically leads to a capital gain or loss, half of which is taxable (a capital gain) or tax-deductible against capital gains (a capital loss).

Although you can sell GICs, they are typically held to maturity. Selling a GIC does not result in a capital gain because the principal amount at purchase and sale or maturity is generally the same.

Let’s look at withdrawals from different account types in more detail.

Withdrawals from taxable accounts

When you withdraw from a taxable account, the withdrawal itself is not taxable (unless it’s from a corporation, which is typically considered personal income, whether salary or a dividend).

Income earned in a taxable account—whether interest or dividends—or a profit from a sale that is taxable as a capital gain is the focus for taxes. The tax on this income applies whether the money is withdrawn or not. So, reinvested income is still taxable.

In your case, Louise, withdrawing your GIC from a taxable non-registered account should not trigger tax. The interest income earned by the GIC would be the only taxable event.

Withdrawals from TFSAs

TFSA withdrawals are never taxable. This is part of the beauty of a TFSA account.

There can be tax implications from TFSAs, though. Interest and Canadian dividends earned in a TFSA are tax-free, but U.S. and foreign dividends are subject to withholding tax. This tax is deducted from the dividends paid to or reinvested within your account automatically.

If you overcontribute to a TFSA, putting in more than your available TFSA room, you can be subject to a penalty tax. (Use MoneySense’s TFSA calculator to find out your limit for this year.)  

Withdrawals from RRSPs

Withdrawals from your RRSP are almost always taxable, though there can be exceptions for withdrawals for a first home purchase or to pay for eligible post-secondary education. The Home Buyers’ Plan (HBP) and Lifelong Learning Plan (LLP) programs allow tax-free withdrawals from your RRSP, but they have required repayment terms.

Otherwise, RRSP withdrawals—regardless of the source of the cash funding the withdrawals—are considered fully taxable income.

RRSPs are typically converted to a registered retirement income fund (RRIF) by no later than December 31 of the year the account holder turns 71. You can also use an RRSP to buy an annuity from a life insurance company, but this is less common. Like RRSP withdrawals, RRIF withdrawals are taxable. 

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Withdrawals from RESPs

Registered education savings plan (RESP) accounts used to save for post-secondary education have different types of withdrawals.

• Post-secondary education (PSE) withdrawals are tax-free. They represent the original contributions made by a contributor.
• Education Assistance Payments (EAPs) are taxable. These are the investment earnings and government grant deposits to the RESP. If a child is pursuing eligible post-secondary education, these withdrawals are taxable to them. If the child does not end up going to post-secondary school, or there is money left in the RESP, the government grants may be repayable to the government, and the withdrawals of investment earnings are taxable to the contributor. There is also a 20% penalty tax in addition to the subscriber’s regular tax rate. There may be an opportunity to shelter up to $50,000 of investment earnings from tax by making a transfer to the subscriber’s RRSP.

Finding tax advice for your investments

Investment income has tax implications, and it can even be subject to withholding tax in a tax-sheltered account. Capital gains are only relevant in taxable accounts. Withdrawals may be taxable, depending on the account.

Not all financial advisors are well versed in tax planning or strategy. If yours does not have all the answers, that is OK—especially if they are upfront about it. This is better than giving incorrect advice. Tax accountants and Certified Financial Planners (CFPs) may be better suited to provide tax advice about your investments and retirement decumulation.

More from Ask a Planner:

• How to manage your tax withholding in retirement
• Should we draw down my spouse’s RRIF faster?
• Is real estate the best investment for a Canadian retiree?
• When and how should I start drawing on my retirement savings?

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