There’s a right way to go about saving for retirement and a wrong way. The wrong way is to invest all your savings in individual stocks you “have a good feeling about,” and hold them in taxable accounts. The right way is to hold a diversified portfolio inside of a tax-advantaged environment.
In this article, I will explore five unstoppable retirement savings hacks, all of which are based on the core principle of tax efficiency.
#1. Put bonds in your RRSP and TFSA
Bond interest is taxed more than dividends or capital gains. So, if you have bonds (or Guaranteed Investment Certificates) in your portfolio, you should hold them in your Tax-Free Savings Account (TFSA) and Registered Retirement Savings Plan (RRSP). They should take precedence over stocks being held in these accounts.
#2. Claim the dividend tax credit
If your RRSP and TFSA are full to the brim with bonds already, that doesn’t mean you have to pay your full tax rate on stocks. Both dividends and capital gains have tax breaks applied to them. Dividend stocks are grossed up in value by 38%, then have a 15% credit removed from the tax. Because of the gross up, the tax savings from the dividend tax credit is actually more like 20% than 15%.
Let’s imagine you held $10,000 worth of Bank of Nova Scotia (TSX:BNS) stock in a taxable environment. Your marginal tax rate is 33%. BNS is a dividend stock that yields 6.7%. So, your $10,000 position yields $670 per year. Scotiabank has delivered a lot of dividend growth over the years, and bank stocks, in general, tend to raise their dividends, so you might actually be getting more than $670 in subsequent years, but let’s ignore that for now.
If you get $670 per year in Scotiabank dividends, the amount is grossed up to $924.6. 15% of that is $138.69 — that’s your tax credit. Your taxes on $670 in dividends are $223. Subtract the dividend tax credit, and you’re down to just $84 — less than half of what you’d have paid without the dividend tax credit.
#3. Don’t sell stocks too early
Another very important retirement savings rule is to not sell stocks too early. Stocks incur more taxes the more often you sell them. If you never sell a stock, and it doesn’t pay dividends, you may pay no taxes at all! Overall, if a company’s stock is worth holding at all, you should hold it long term.
#4. Pay off (high-interest) debt before you invest
A related rule is to prioritize paying off high-interest debt before you invest. Credit cards charge about 20% in annual interest these days. It’s unlikely that any stock or bond you pick will do better than that. So, definitely prioritize paying off debt before you invest in the stock market — especially if the debt has a high interest rate.
#5. Diversify your investments
Last but not least, one of the most important rules of saving for retirement is to diversify your investments. If you put all your money into one stock and the company goes bankrupt, you could lose all of your investment. But if you hold 100 stocks or an index fund, the odds of that happening go much lower. So, diversify your investments. It reduces your risk of loss.
