May 6, 2009

Protect your investment gains

One of the many mistakes made by investors if that they often neglect to protect their gains from the burden of taxes. Don’t get me wrong, I am not talking here about illegal means to avoid taxes, there are many ways to save taxes and at the same time remaining compliant with tax laws. The examples I will be showcasing are more specific to the US and Canadian financial systems, but I’m pretty sure it shouldn’t be very hard for somebody industrious enough to find them for their local jurisdiction.

The first tools are traditional retirement savings plans. In their case, the contributions are tax-deductible. So for somebody who is in the 30% marginal tax bracket contributes 5000$ in that plan, he will see his tax return or his tax obligation respectively increase or decrease by 1500$. An investor could use them since they allow for a variety of investment vehicles, ranging from CDs (GICs in Canada) to Stocks, which is of interest. The taxpayer gets the tax benefit during the fiscal year that the money is invested. In the US, there are the IRA (Individual retirement account) and the 401(k). In Canada, it is the RRSP (Registered retirement savings plan) that offers the same advantages. To me it seems it would be very useful for people in higher tax brackets to maximize those types of account.

People in lower tax brackets and some money to spare will find the second type of investment account very interesting. It has been available for a while in the US and has been offered to Canadians only since January 2009. Contributions to a those accounts are not deductible for income tax purposes but their biggest advantage is that investment income, including capital gains, earned in a TFSA are not taxed, even when withdrawn! I might be wrong, but it looks to me like the last tax haven available to the middle class. In the US, they are called Roth IRAs and in Canada, they are named TFSA (Tax free savings accounts). Put the issuance of TFSAs the, the Canadian government provided a graph showcasing the long-term tax advantages:

People not familiar with those accounts should meet with their investment advisor to get more clarifications about them. This article gives only a glimpse of their characteristics and an investor serious about his long term success should think about implementing them in their investment strategy. There should be more effort put in maximizing them to the limits than since they will provide tax relief in the present and untaxed profits in the future.

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