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FP Answers: How do I calculate the real return on my investment, that is, after paying the tax?

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FP Answers: How do I calculate the real return on my investment, that is, after paying the tax?

Most investors don’t think enough about after-tax returns from unregistered investments

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FP Answers puts your investment questions to the experts. This week our expert is Allan Norman, an investment advisor at Aligned Capital Partners Inc. Whatever your investment question, ask us, because FP Answers.

Q: I’m 50 years old and I make my own investments, but I’m not sure what is the correct asset allocation for me in terms of stocks / bonds / alternative investments when it comes to income needs and tax efficiency. I am especially confused about how to calculate my annual after-tax returns, as investments accumulate in my unregistered investment account, but I am paying taxes from my personal checking account. – Thanks Sabina

FP responses: It’s smart to ask about after-tax returns on unrecorded investments, Sabina. I don’t think most investors think enough about this. Once you have a general awareness of the tax implications, the answer to your asset allocation question will be obvious.

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The accompanying table shows the after-tax returns on a $ 100,000 investment with a gain of five percent. To get the total tax bill, I’ll assume you live in Newfoundland, earn $ 130,000 a year, and your spouse earn $ 20,000.

Tax on dividends and interest income is paid annually and tax on capital gains is paid when the profit is triggered, typically when property / equity is sold or there is a change in ownership.

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You’ll notice that only interest income is taxable in its entirety. I assumed that investments with dividends and capital gains also have some appreciation, which is not subject to tax in the current year.

It’s easy to see that interest income is the most taxed, while capital gains, in most cases, are the most tax efficient. The exception is when you have low taxable income. In that case, dividend income may be the best.

If you look at the table again, you can probably see how you could allocate your investments in registered and unregistered accounts. The most taxed investments, such as guaranteed investment certificates, bonds and some alternative investments, would go to registered accounts (registered retirement savings plans (RRSPS), registered retirement income funds (RRIF), tax-free savings accounts (TFSA), etc.) Stocks or other investments with very few taxable distributions would go to unregistered accounts.

If you have a spouse or partner, it may make sense to have unregistered investments in your name. To do this, the low-income person would put their income into investment and the high-income person would pay living expenses.

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Passive or indexed investments may be better placed in an unregistered account than active investments which often have higher turnover rates and therefore larger distributions.

Of course, there are other factors to consider when allocating assets, such as risk tolerance, income needs, performance objectives, and lifestyle goals. When these are factored into asset allocation, you usually have to commit to the tax.

Calculating your after tax return is not difficult using this simple formula:

[(ending market value – tax paid) – (beginning market value)]/ (initial market value)

Using the numbers in the table, we will calculate the after-tax return of $ 5,000 of interest income:

[($105,000 – $2,090) – ($100,000)]/ 100,000 = 2.91 percent

To find the tax paid, multiply your marginal tax rate (MTR) for the income type by the income or interest distribution. Continuing with our example, the tax paid is as follows:

Interest: 41.8 percent MTR x $ 5,000 distribution = $ 2,090

Dividends: 29.9 percent MTR x $ 4,000 distribution = $ 1,180

Capital gains: 20.9 percent of MTR x $ 2,000 distribution = $ 418

The taxable interest or distribution can be found on your T5 or T3 Tax Voucher Investment Income Statement, depending on the type of investment.

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An easy way to get the MTR for your income, dividends, and capital gains is to use a personal tax calculator. Enter your annual income and then one at a time add the interest income to your personal income and check your marginal tax rate. Then remove the interest income from your income and add the dividend income to your income, and check your MTR to see the dividends. Follow the same procedure for capital gains.

With the formula above, you have all the information you need to calculate your after-tax returns. Give it a try, Sabina, it’s not that difficult when you master it.

Allan Norman, M.Sc., CFP, CIM, RWM

Allan Norman is a certified financial planner and investment advisor to Aligned Capital Partners Inc. and can be contacted atwww.atlantisfinancial.ca or [email protected].

This comment is provided as a general source of information and is intended for Canadian residents only. Allan offers financial planning and insurance services through Atlantis Financial Inc.

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