Taxes – RRSPs and TFSAs – Tax Deferral Accounts and Tax-Exempt Accounts Taxes are a reality for all investors. Although the capital gains tax for profitable investments is lower than that of normal income tax, there is a large tax drag on investment returns due to its impediment to compounding returns. Depending on an investor’s tax jurisdiction, taxes can be more or less cumbersome pertaining to investing. Regions such as Hong Kong have stamp duty in lieu of capital gains tax – this allows for a much better compounding of gains but at the expense of a small upfront capital charge. This makes high frequency trading far less lucrative. In North America, Canada and the US both have capital gains taxes – gains from investing are taxed and losses from investing can be carried over to negate gains in future years. To encourage investment, capital gains taxes are usually taxed at a lower rate than income (~half of the marginal income tax rate on salary). Accordingly, investors should strategize on where to put certain investments and how to minimize taxes (both for their salary and from investments) in order to compound wealth effectively. Contents1 Capital Gains Tax on Non-Registered Accounts2 Tax Deferral Accounts – RRSP, RESP3 Tax Exempt Account – TFSA4 Capital Gains Tax on Cryptocurrencies5 Related Reading for Investing5.1 Investment Asset Classes5.2 Commentary on Investing Capital Gains Tax on Non-Registered Accounts Every time gains are realized in a non-registered investment account, tax will have to be paid at the end of the year. The negative effect of this is twofold – one, the tax paid is money that cannot be used to continuously compound future gains; two, if the money is not set aside now, the market could fall causing the investor to realize a loss to take money out to pay the government. As such, the best strategy for non-registered accounts is to take money out sparingly and hold investments for a long time. Most notably, this would be setting aside the same amount each paycheque to put into a market ETF – averaged over time, this means allowing the compounding of a steady and attractive return over a long-time horizon without realizing capital gains until much later. Bonds with near term maturities are not sensible for these accounts because gains will have to be realized at expiry. For individual securities, the best companies to purchase are ones to be held forever – although should the stock rise too far above fair value, they should still be sold. Tax Deferral Accounts – RRSP, RESP Tax deferral accounts allow for the selling of securities within the account without paying capital gains tax as long as the money stays in the account. This also applies for distributions or dividends earned in the account. Once the money is taken out, the cumulative capital gain (what you took out versus what you put in) is taxed. The RRSP is especially attractive as it comes with the feature that income from normal salary can be allocated to the RRSP up to a maximum contribution each year which does not pay tax until the year it is taken out, shielding salary from tax and allowing for an investor to compound wealth. However, money taken out of the RRSP is taxed on the whole amount as opposed to just the gain. Even if you have a cumulative loss on the RRSP, any withdrawn amount is included in that year’s taxable income. With these characteristics in mind for TDAs, opportunistic investing should be conducted here (anything with more buying and selling) as opposed to buy and hold for normal accounts. Tax Exempt Account – TFSA Up to a certain contribution limit, anything put into these accounts will not be taxed – whether capital gains, dividend income or interest income. Capital Gains Tax on Cryptocurrencies At least in Canada and the United States, yes you do have to pay tax on your Bitcoin trading profits. Bitcoin is not recognized as a currency and is subject to capital gains tax as with any other asset. Related Reading for Investing Investment Asset Classes Fixed Income – An introduction to bonds and other fixed income instruments Index ETFs – An introduction to index ETFs and why they make sense versus most mutual funds Avoiding Exchange Rate Fees at Banks for Investing and Travel Gold Real Estate Taxes – All investors have to deal with taxes but it is important to know how to minimize tax drag on your investments through understanding TFSAs and RRSPs Commentary on Investing InvestingWhat I Missed About Tesla Stock · Are Stocks Cheap After COVID-19 – Part II · Real Estate Investment Considerations and Strategies · Why Investment Bankers Are Bad Investors · The Sky Is Falling · Beginning Investor Q&A · Choosing the Right Investment Advisor · Understanding China and the Investment Thesis · Emerging Markets We Are Investing In Right Now (for Canadians) · Investing in Stocks Today with the Trump Backdrop · Buying Property as an Investment for Young Professionals · Observations on Chinese Assets and Investing · Should You Enroll in the Company Employee Share/Stock Purchase Plan (ESPP)? · Dividend Reinvestment Plans (DRIP) · Investing Mistakes for Family and Friends · A Conversation About Risk and Reward · Share on Facebook Share Share on TwitterTweet Share on LinkedIn Share Print Print