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A lot of people live their entire lives as investors within the universe of tax-sheltered investing.

These investors never use up all the contribution room in their tax-free savings account and registered retirement savings plan. And so, they never have to worry about limiting taxes in a non-registered investment account where gains aren’t sheltered from taxes on a year-by-year basis.

If you’re one of the diligent, fortunate ones who are branching into taxable investing after using up all your RRSP and TFSA room, then a general rule to follow is that capital gains generate the mildest tax hit, followed by eligible dividends and then interest from bonds or guaranteed investment certificates. But the degree of difference between these three forms of investment gains differs from province to province.

To document these differences, let’s use the 2019 Ernst & Young personal tax calculator. We’ll set $150,000 as the annual income level to compare tax rates.

The first thing you’ll notice when you do this comparison is that the marginal tax rate on capital gains and dividends is much lower than on regular income. A quick example: An Ontario resident making $150,000 would have a marginal tax rate of 46.4 per cent on income (including interest income from bonds or GICs), 23.2 per cent on capital gains and 29.5 per cent on eligible dividends. These differences reflect the 50-per-cent inclusion rate on capital gains and the dividend tax credit.

In British Columbia, Alberta, Saskatchewan and New Brunswick, the gap between the tax rate on capital gains and eligible dividends at $150,000 in taxable income is negligible – about 1.4 to two percentage points. In other provinces, there’s a strong benefit to containing taxes by emphasizing capital gains as opposed to dividends.

Ontario is one example, but there are others. In Quebec, the marginal tax rate on capital gains would be just under 25 per cent, while the rate on dividends would be 35.4 per cent. In Newfoundland, a 23.2-per-cent marginal tax rate applies on capital gains and a 35.7-per-cent rate hits dividend income. Other provinces with a lot of daylight between the tax hits on capital gains and dividends include Manitoba and Nova Scotia. Prince Edward Island is mid-pack in the differential between dividends and capital gains.

Portfolios should be designed according to fundamentals like age, risk-tolerance and investing goals, but taxes are also important in a non-registered portfolio. If you want to limit taxes-owing, it pays to understand the tax hit on dividends and capital gains in your particular province.

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