Before choosing new investments for her portfolio, Sallia wants to know how taxes would affect different options. Sallia:
• Has $10,000 to invest for 10 years
• Earns enough money to be in the top tax bracket
• Lives in Ontario.
Where would Sallia make the biggest return after tax? A Guaranteed Investment Certificate (GIC)? A dividend-paying stock? A stock that she sells and earns capital gains on?
To make it easy to compare, let’s say each choice earns the same 4% return, or $400 a year. How much of that return would Sallia actually get to keep, after taxes? These two charts shows what she makes with each investment after one year, and then 10 years later. You'll see:
• Her return if she shelters her investments from tax (and does not pay tax until she takes money out)
• Her tax rate if she does not shelter her investments from tax
• What she makes (her net return after tax).
After one year (2005 tax rates):
|
Investment
|
Return on tax-sheltered investment |
Approximate tax rate on unsheltered return |
Net return after tax
|
|
A GIC earning 4% interest per year (compounded annually) |
$400 |
46.4% |
$214.36 |
|
A stock paying a 4% dividend yield per year |
$400 |
31.3% |
$274.64 |
|
A stock you buy and sell to earn 3% per year |
$400 |
23.2% |
$307.16 |
After 10 years (assuming the tax rate does not change):
|
Investment
|
Return on tax-sheltered investment |
Approximate tax rate on unsheltered return |
Net return after tax |
|
A GIC earning 4% interest per year (compounded annually) |
$4,802 |
46.4% |
$2,573 |
|
A stock paying a 4% dividend yield per year |
$4,802 |
31.3% |
$3,297 |
|
A stock you buy and sell to earn 4% per year |
$4,802 |
23.2% |
$3,687 |
Note: These examples assume that Sallia will earn the same amount from stocks as from a GIC. In reality, that’s very unlikely. Historically, investors in stocks have earned more over the long term. Their investment costs, including commissions, will also be higher.
Remember: Tax really adds up, especially on interest.
That’s why many people shelter investments that earn interest. They hope to pay less tax when they take the money out later in life, when their income may be lower.