Q.

I’d like to diversify out of just my

guaranteed investment certificates

(GICs) into dividend or potential capital appreciation stocks. How should I do this? I am in the process of deciding how to invest about $600,000 that I received from the sale of my home. I have maxed out my

tax-free savings account

(TFSA) into a global equity

exchange-traded fund

(ETF) and have purchased $400,000 in laddered GICs with terms of one to three years but would be interested in the potential of a better return on investment than GICs. I also have about $75,000 in unused

registered retirement savings plan

(RRSP) room but am only working part-time right now, earning $30,000 annually, so have passed on putting money into it for the past four years. Any recommendations you have to increase returns and minimize taxes in the coming years would be helpful.

—Lino

FP Answers:

Your decision to not use the RRSP contribution room with the proceeds of your home sale and focus on maximizing your TFSA are good starting points as you implement your new investment strategy, Lino.

At your income level of $30,000 annually, plus any potential taxable income generated from your new GIC ladder, I would not recommend making RRSP contributions at this time. Your tax refund for the contribution may not end up more than a 20 per cent refund at your current marginal tax rate, whereas your withdrawal could end up being taxed at a higher rate in future years. RRSP contributions could be more beneficial if you begin working full-time or as your investment income grows.

Tax-deferred compounding of investment income is one of the key features of the RRSP account. But because withdrawals are taxable, it is not always a sure thing to contribute. It works best when using deductions to lower your taxable income during your working years to generate a refund and then withdrawing from the RRSP in

retirement

at lower tax rates.

At your income level, there is a unique opportunity to earn investment income outside a TFSA in the form of Canadian dividends, tax-free, up to certain income thresholds. For taxpayers with taxable income of $50,000 or less in most provinces, dividends would be tax-free due to the dividend tax credits that are used to offset tax payable for investors in Canadian stocks. Even beyond that point, Canadian dividends are taxed favourably.

Additionally, capital gains triggered on the sale of any stocks in a taxable account would only be 50 per cent taxable. So, half the appreciation in your stocks is tax-free.

Canadian stocks tend to have higher dividends than U.S. stocks, so are biased more toward income than capital appreciation. You do have to be careful about focusing solely on the tax merits of Canadian stocks though, because Canadian stock markets are not as well diversified as U.S. markets. U.S. dividends may be taxed at a higher tax rate, but because your return can be tax deferred — capital gains aren’t taxable until you sell — they can still be very tax efficient in a taxable investment account.

If you already invested your TFSA in global equities, you could take a more Canadian investment focus in the non-registered account where there are tax benefits to hold those stocks.

By comparison, your GICs will generate interest income, which is taxed at the same rate as other forms of income such as employment or pension income. If you shifted more of your equities to the non-registered account you would more efficiently use the concept of asset location planning and have a better after-tax outcome.

Since you have already invested the bulk of the proceeds into a GIC ladder you could stagger your investments into stocks as the GICs mature.

When it comes to investment income, focusing on tax minimization serves an important purpose but it should not be the only consideration. For someone with a high risk tolerance, no income needs and a long-time horizon, however, a tax efficient stock portfolio works well.

If you have been a GIC-focused investor or opted to buy GICs with the proceeds of the home in order to be conservative and maintain capital, then moving too deep into stocks may not be appropriate. Having your TFSA fully invested in equities while having most of your other funds locked into GICs over the next three years does prevent you from taking inordinate risks with the proceeds of your sale, but as your GICs mature you can start to take more risks, as appropriate.

If you are not used to the volatility that comes with investing in the stock market, monitoring your TFSA global equity portfolio over the short- to medium-term and evaluating your reaction to market swings is a good way to self-assess how you feel about risk.

Using your “gut” feeling can be a reliable gauge of how you should invest but it should be supplemented with an evaluation of your client investor profile, which we recommend both DIY investors and clients with investment managers complete annually. After all, risk tolerance can change over time.

  • Laid off at 52, no pension and $250,000 in RRSPs. Is retirement a pipe dream?
  • Does a prenup agreement trump a will at death?

Andrew Dobson is a fee-only, advice-only certified financial planner (CFP) and chartered investment manager (CIM) at Objective Financial Partners Inc. in London, Ont. He does not sell any financial products whatsoever. He can be reached at adobson@objectivecfp.com.