Taxation of your investments plays a critical role in personal finance. To maximize after-tax returns, investors must minimize controllable costs, one of the most significant being taxes. Understanding how different types of investment income are taxed can help inform more effective investment decisions and support the tax planning process.
Registered accounts such as the TFSA and RRSP offer structural advantages that shelter various forms of investment income from tax. TFSAs allow an investor to contribute after-tax dollars and grow their money tax-free. Eventual withdrawals are also free of tax implications. RRSPs provide a tax deduction up front, tax deferred growth, and are fully taxable upon withdrawal. Unfortunately, these accounts have contribution limits and strong savers are eventually forced to rely on non-registered accounts. These accounts, also referred to as taxable, open, or cash accounts, do not provide tax sheltering. Instead, investment returns are taxed based on their unique characteristics.
There are three primary sources of investment returns: interest, dividends, and capital gains.
Interest income is generated from instruments such as bonds, guaranteed investment certificates (GICs), and savings accounts. Dividends are distributions of the after-tax profits of a corporation to its shareholders. These payments are typically issued quarterly at the discretion of the company. In contrast, interest payments are the result of contractual obligations and therefore, not discretionary. Capital gains arise when an investment is sold for more than its purchase price.
Interest payments and foreign dividends are taxed at the owner’s marginal tax rate. For example, suppose someone in Ontario earns a $60,000 salary annually. They receive $100 in interest over the year from their high interest savings account and hold Microsoft shares in a taxable investment account. They also received a $100 dividend from Microsoft this same year. Both the interest from their savings account and the dividend from Microsoft will incur taxes of $29.65, calculated at the owner’s 29.65% marginal tax rate.
Dividends from Canadian corporations receive preferential tax treatment through a gross-up and tax credit mechanism. The rate of tax paid on dividends will again depend on your income. For example, say you own shares in RBC. In 2025, you received dividends worth $100 from your investment. At $60,000 of employment income, your tax would look like this:
Capital appreciation on a stock or bond is only taxed when the investor sells the asset.
Unlike interest and dividends, capital gains are only taxed when an asset is sold for a profit. Capital gains are taxed at half of your marginal tax rate. For example, the $60,000 salary earner sells their 50 Microsoft shares for $100 dollars each, resulting in total proceeds of $5,000. They originally purchased their Microsoft shares 3 years earlier for $75 apiece. The resulting capital gain on this sale is $25 per share, or $1,250 total. Half of the capital gain will be taxed at the investor’s marginal rate, creating a tax liability of $185 ($1,250 gain * 50% inclusion rate * 29.65% marginal tax rate). Capital losses (in other words, selling a stock or bond at a loss) may be used to offset capital gains realized in the current year, carried back up to three years, or carried forward indefinitely.
From a tax efficiency standpoint, capital gains and Canadian dividends are more advantageous than interest income when received taxable accounts. As income levels rise, capital gains tend to become increasingly tax efficient relative to dividends. At lower income levels, however, Canadian dividends benefit from particularly favorable tax treatment.
While tax efficiency is an important consideration, it should not be the primary driver of investment decisions. Investors should first select investments that align with their financial goals, risk tolerance, and time horizon. Ultimately, most investors will be best served using a low-cost, broadly diversified, global portfolio with low turnover.
