Income is Important, but Cash Flow is King
“It’s not what you earn but what you keep that’s important”, meaning that you must minimize taxes and maximize cash flow to keep more of what you earn.
Understanding how various forms of income are taxed is helpful to understand what you can do to adjust your income resources where possible to lessen the burden of tax.
As an employee you receive a regular income. As a retiree you still receive your pension which is categorized as regular income too. Interest income is taxed the same as employment or pension income. Every dollar received is taxed at your marginal tax rate.
For the purpose of this discussion, we will use the highest marginal rate in Ontario, which is 46.41%. This means that on every $100 interest income you would pay $46.41 in income tax, netting you $53.59 after tax income. (Just to clarify: Not all of your income is taxed at this level, just that amount above the threshold where the 46.41% begins, which is $127,000. If your regular and interest income is lower, then the marginal rate will be lower too, but for the purpose of this example, just lets use this marginal rate.)
Dividends from Canadian Corporations are better source of income, because they are taxed differently.
Dividends from Canadian corporations are taxed at 31.3% and as a result you keep $68.70 for every $100 received. If you own common shares in a company that appreciate in value (and most companies do) you will trigger a capital gain when you sell your shares.
Capital Gain is the difference between what you paid for the shares and what you sell them for. Now look how the tax changes with capital gain: for every $100 received in capital gain you pay only 23.20% which means you keep $76.80. What’s even more important to understand is – when capital gain occurs you pay taxes only on one half of your gains. The other half is tax free.
One other form of income is Return of Capital (ROC). When you invest in a mutual found, that offers ROC, you can significantly increase your cash flow because the taxes you would otherwise pay are deferred into the future. When the found is eventually sold, the income will be treated as a capital gain, wish is very favorable (just as described above) for investors.
Unfortunately, investments help in RRSP lose the benefit of dividends, capital gains and return of capital. All income from registered accounts is treated as ordinary income and therefore taxes as a regular income.
From a tax point of view, income from an RRSP and RRIF is the least efficient because it must be treated as a regular income. On the flip side if you are taxed at a higher marginal rate while you’re working and looking to save on taxes, RRSP is a great investment to reduce your present taxes and enjoy the benefits of deferred taxation. Many people when they use their income from RRSP’s are in a lower tax bracket as they are while working.
It’s really important to understand what’s the most beneficial for your personal financial situation: both for the present and for your future as well. By adjusting your income sources could help you lessen your taxes.
Do you have any dividends income in your portfolio? Do you focus on capital gain producing investments too? What is your personal strategy to keep the cash flow in your pocket?
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- Some Questions about Cash Value
- Is Life Insurance a Good Investment?
- Choose the right savings vehicle for your dreams.
- Bank of Canada Lowers Interest Rate
- How to Be Financially Secure at Any Age?
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