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Prepare for a tax hit on the interest you’re raking in from savings accounts and GICs this year.

The big rise in interest rates over the past year means banks and financial companies will be issuing a lot more T5 slips this year to document interest income paid to clients. While tax filing for 2022 is months off, it’s not too soon for savers and conservative investors to prepare for a bigger tax bill as a result of higher rates.

Rates on savings accounts are just above 3 per cent at best and the top rates on guaranteed investment certificates range from 4.8 per cent for one year to 5.18 per cent for five. With stock and bond markets both down sharply this year, these rates are a powerful incentive to park money safely.

“A lot of money is sitting in cash right now, and these types of parking spots tend to produce interest income,” said Wilmot George, vice-president of tax, retirement and estate planning at CI Global Asset Management.

Keeping money safely stowed in savings and GICs is logical in these uncertain times, but there are costs. Rates on savings lag inflation, which means the purchasing power of your savings is declining. And then there’s the tax treatment of interest income.

Interest is taxed like regular income in non-registered accounts as opposed to tax-free savings accounts or registered retirement savings plans and registered retirement income funds. Taxes are deferred with RRSPs and RRIFs until you make a withdrawal, which is treated as regular income. Gains in a TFSA are, of course, tax-free.

Dividends paid into a non-registered account benefit from the dividend tax credit, while capital gains are subject to a rule that you pay tax on only half your gain. Such is the tradeoff with safe havens that pay interest. “They tend to be less volatile, but the flip side is that the income you generate tends to be less efficient,” Mr. George said.

Someone earning $100,000 a year would face a marginal tax rate on interest income of as much as 41.1 per cent in Quebec and between 30.5 and 38 per cent in other provinces, according to the EY 2022 personal tax calculator. At $225,000, the marginal tax rate on interest income is a little more than 50 per cent in Manitoba, Ontario, Quebec and the Atlantic provinces.

Investors holding non-registered accounts need to prepare as much as savers for higher taxes on interest. The Top Three most popular exchange-traded funds as ranked by inflows of money in September were cash alternative ETFs, also known as a high interest savings funds. These ETFs invest their assets in bank savings accounts that offer a reliable flow of income yielding about 3.6 per cent these days.

Other investing products that pay interest include high interest savings mutual funds, which are like cash-alternative ETFs in offering a productive place to park cash in an investment account.

T5 slips are where banks, credit unions and investment companies report interest income, as well as dividends and other distributions from investments or funds. The Canada Revenue Agency does not require these companies to report interest income of less than $50 in a year, although taxpayers are expected by the CRA to report smaller amounts on their own.

Without substantial amounts held in savings, you may not have seen many T5s in recent years because rates were so low. But with a $2,500 balance, even a 2 per cent rate gets you into the T5 zone.

Drawn to GICs this year because of their much-improved rates? Whether your non-registered GIC pays interest monthly, semi-annually, annually or on a compounded basis at maturity, you must report the interest that accrues each year. Again, you’ll get a T5 slip from your GIC issuer.

There’s still enough time left in the year to ease the tax burden posed by interest income. Holding GICs, or even savings, in a registered account is one option. “In an ideal world, you’d like to have your interest-bearing products within your registered plans – TFSAs, or RRSPs and RRIFs,” CI’s Mr. George said.

Much is rightly made of the burden higher interest rates place on borrowers, but there’s a positive impact as well for savers and conservative investors. Unfortunately, higher rates will prove to be a taxable benefit for many people.

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