Rethinking asset location

The so-called “new normal” of ultra-low interest rates continues to lay waste to long-standing investment practices.

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Conventional wisdom tells us that interest-bearing investments, such as bonds, should be held in registered accounts, while equities should be held in non-registered accounts.

The logic to this is that interest income is taxed as income, while dividends and capital gains receive preferential tax treatment.

It may be time to reconsider this practice though, according to Jamie Golombek, managing director of tax and estate planning at CIBC Private Wealth Management.

“Where the yield is so low that fixed income is paying 1% on average, the potential tax savings of holding those investments in an RRSP or TFSA, even if you’re in the top marginal rate of 50%, would be maybe 50 basis points,” he says.

“It may be wasting the opportunity to earn tax-free income in a registered plan by allocating such low-yielding investments in that registered plan.”

Instead, it may make more sense to hold equity investments in the registered plan, as they are likely to generate more taxable income even though they receive preferential treatment.

“Over the long term, we could generate maybe 5% or 6% on equities, then perhaps it’s better to put those equities inside the RRSP where we can generate that tax-free return,” he says. “It’s not just the absolute tax savings, its the tax rate multiplied by the rate of return.”

The flipside of low bond yields is that their capital values have been bid up. This makes a capital loss more likely down the road, which would be wasted if generated inside a registered plan.

“This question of asset location is really only relevant to investors who do not have any more registered room—an investor who has fully maximized their RRSP and their TFSA,” Golombek points out.

Staff

The staff of Advisor.ca have been covering news for financial advisors since 1998.