A Non-registered Investment Account, also commonly referred to as a Cash Account or Margin Account, is a standard investment account where Canadians can save and invest money for the long-term or for the short-term. These accounts are easy to open with any self-directed brokerage platform and are a basic investment account. Not all non-registered accounts provide access to margin loans. If you would like access to credit through margin loans, your brokerage will typically need verify your credit and income.
Unlike the RRSP or TFSA, a non-registered investment account carries no tax sheltering, tax contribution, or withdrawal privileges. They are typically best for Canadians who are saving money beyond the contribution limits of their TFSA and RRSP accounts. Some more active trading strategies, or strategies which employ leverage, are also best done in a non-registered investment account to take advantage of tax benefits for investment loans and margin loans, or to invest in an active style that might not be permitted in a registered account.
Non-registered accounts are open brokerage accounts where you have wide access to markets with leverage, active trading, non-qualified investments, and any style of investing you are comfortable with. They are virtually unrestricted, save for exchange rules, brokerage rules, and your personal situation.
Contents of Investment Account Guide
- What is a Non-registered Account Exactly?
- Basic Tax Structure
- When Should I Contribute to a Non-registered Account?
- Transferring Your Non-registered Account
- Reducing Your Tax Costs
- Non-residents and Non-registered Accounts
- Dying with a Non-registered Account
What is a Non-registered Account Exactly?
A Non-registered Investment Account is a baseline investment account with no special tax privileges. While in this article we are referring to trading accounts at online brokerages, even a standard savings account or term deposit at your local bank is a type of non-registered account. An investment in rental real estate is also a non-registered investment, although it is a business activity rather than a capital activity.
The greatest advantage of a non-registered account is they are extremely flexible with few limitations in any way. You can contribute an unlimited amount of money to your account, you can invest in basically everything that is publicly traded including private equity, and you can withdraw any funds you have in the account at anytime without restrictions.
The taxes you must pay on realized income and capital gains will reduce your overall returns. Realized income and realized capital gains must be reported every year and you must pay any taxes owing on these gains. This means your net investment returns will always be somewhat lower in your non-registered account than returns on comparable assets in your TFSA or RRSP accounts.
You can open and manage your own non-registered investment account via a self-directed brokerage account like Interactive Brokers or Questrade, or you can hire an advisor to manage your investments on your behalf.
Basic Tax Structure
It is important to understand the tax structure and tax implications of investing in a non-registered investment account. Understanding the tax situation will help you decide if you should invest within a non-registered account, or if you should focus on your TFSA and RRSP accounts instead.
- You contribute to a non-registered account with after-tax income.
- If you are an employed person, you will generally have income taxes withheld from your paycheque. Your after-tax, or net income, is lower than your pre-tax, or gross income. You are contributing to your non-registered account with money you have already paid taxes on.
- Unlike with RRSP contributions, you cannot deduct your non-registered account contributions from your taxable income when filing your taxes.
- For example, if you earn $50,000 and pay income tax of $10,000 on that income, you contribute to your non-registered account from the $40,000 after-tax income level.
- You must pay taxes annually on investment income earned within your non-registered account.
- When you invest, you will likely be generating investment income such as dividends or interest payments. You may also realize capital gains when selling your investments in your non-registered account at a profit. Any income or profit earned within your non-registered account must be reported each year and you must pay the taxes with your return by the end of April of the following year.
- For example, if you earn $50,000 a year at work, your non-registered investments earned interest income of $5,000, and you sold an investment in your non-registered account for a profit of $25,000, you need to report and pay taxes on the $50,000 you earned at work, the $5,000 of interest income you earned, and your capital gain of $25,000 (minus any realized capital losses).
- Money you withdraw from your non-registered account is not reported and not taxed.
- You can pull money out of your non-registered account at any time and pay no taxes on that withdrawal. You also do not report the withdrawal on your tax return. It does not count as income since you already have paid taxes on any realized income or capital gains earned within the account.
- For example, if you earned $50,000 a year and work and you withdrew $10,000 from your non-registered account, you will only need to claim the $50,000 you earned at work. The money you withdrew from your non-registered account is yours to keep free of taxation once you have paid the taxes owing on gains earned within the account. If you sell an investment with a $10,000 capital gain and then withdraw the money from your account in cash, you will need to report and pay taxes on the capital gain when filing your taxes by the end of April in the following year.
You can think of your non-registered account as an investment vehicle with no tax benefits. It is simply an open investment account. You must pay taxes on any investment income or realized capital gains earned within your account. Different forms of investment income are taxed at different rates:
- Interest income: Interest income you earn in your non-registered account, including ETFs that pay interest income, is taxed at the same rate as employment income.
- Foreign dividends: Dividends paid from foreign corporations, including ETFs that hold foreign stocks, are taxed at the same rate as employment income. However, you may claim back a credit for any withholding taxes already paid to foreign governments.
- Canadian dividends: Dividends paid from most Canadian publicly traded stocks, including ETFs that hold Canadian stocks, are taxed at preferential tax rates. The tax rates vary by income level and province of residence, but can be as low as -9.60% and as high as 42.61%. (Negative tax rates can only be used to offset other taxes owing.)
- Capital gains: Capital gains earned from selling an investment at a profit is taxed at the same rate as your employment income; however, only half of the capital gain is included as income, the other half is tax free. Realized capital gains may be offset by capital losses. Capital losses can be carried back up to three years and carried forward indefinitely.
- Return of capital: Certain real estate investment trusts and ETFs pay a distribution called return of capital. Return of capital is not taxed per se, but reduces the cost base of your investment for tax purposes. Once your cost base is down to zero, return of capital is taxed as a capital gain.
Since several forms of investment income are taxed under preferential terms, you can benefit from being selective about the investments you choose within your non-registered investment account.
When Should I Contribute to a Non-registered Account
Every Canadian who has fully funded their TFSA and RRSP accounts should open and contribute to a non-registered investment account regardless of their income level and use for the account. Canadians who are active traders, who sell options (especially "naked" options), and those who borrow to invest as a core part of their strategy should use a non-registered account for this kind of trading.
A non-registered account should typically only be used if you are saving money beyond the maximum contribution you can make to your TFSA. If you can benefit from investing in a RRSP account, you should also contribute as much as possible to your RRSP before using a non-registered investment account. However, certain Canadians should avoid RRSPs and may skip directly to a non-registered investment account instead after fully funding their TFSA.
While you should count on paying some taxes when investing in a non-registered account, being selective about your investments can help significantly reduce your taxes. The less tax you pay on your investments, the higher your true gain will be relative to your posted gain.
Investing in publicly traded Canadian corporations which pay dividends can be very advantageous for lower income Canadians. If you earn less than $47,630 per year including your dividend income (in 2019), you can find yourself paying negative tax rates on your dividend income. You won't receive a refund cheque for the negative tax, but you can use the negative tax rates on your dividends to offset your other taxes owing. This includes reducing any taxes owing on employment income, pension income, or net capital gains.
Anytime you borrow money to invest, whether that's through a margin loan, a HELOC loan, or borrowing with a RRSP non-arms length mortgage, you should invest the borrowed money in a non-registered account. Borrowed funds for investing in a non-registered account are eligible for interest and carrying cost deductions. Depending on your income level and province of residence, this can reduce your effective interest rate and loan administration costs by up to 54% from the posted rate.
Transferring Your Non-registered Account
Non-registered accounts are extremely flexible. You can open an unlimited number of non-registered accounts and there is no need to keep track of contributions or withdrawals. You must only track for income earned in the account each year.
However, for money management reasons you should minimize the number of accounts you have. It is far easier—and you have more options to invest—managing one large account than managing five accounts with much smaller sums. Having one account at a good brokerage and transferring all of your non-registered investments to that brokerage can be very beneficial.
Choose a brokerage that offers good pricing and borrowing terms for non-registered accounts. Commission-free ETF purchases are a huge perk, but it is also nice to have the potential to access margin loans at low costs. This is true even if you don't think you will use margin loans in your current investment strategy.
- Interactive Brokers is the go-to brokerage for a non-registered account for investors and traders. They have a very powerful platform, their fees are low (although they offer very limited commission-free ETFs), and their margin loan rates are second to none.
- Virtual Brokers may be the second best choice for Canadian investors. They offers commission-free ETF purchases on all North American ETFs and their margin loan rates are lower than average. Plus, their platform is known to be user friendly and reasonably powerful.
- National Bank Direct offers reasonable margin loan rates and commission-free ETF transactions on all trades over 100 units. NBDB can be a great choice for investors who are looking for a generally good brokerage where they will only be purchasing ETFs. NBDB is known for a poor interface and mediocre trading platform.
- Questrade offers commission-free ETF purchases, regardless of the transaction amount, but their margin loan rates are not very competitive. While Questrade is great for registered accounts, I would be hesitant to use them for non-registered accounts until their margin rates are reduced.
If you have several non-registered investment accounts spread across different brokerages, consolidating into a single good brokerage is a wise decision. However, unlike transferring RRSP accounts or TFSA accounts, transferring non-registered accounts incorrectly can trigger large tax consequences when not done correctly.
Here is the correct process to transfer non-registered accounts to another non-registered account:
- Choose a brokerage that provides the services you are looking for and open a non-registered account with them.
- Examine your existing non-registered account for investments which are in a loss position (their current value is less than their adjusted cost base). Consider selling these investments and booking the capital loss. This is a good time to get rid of old investments which no longer fit your investment plan.
- Examine your non-registered account for investments which have unrealized gains. If you have booked any capital losses, or if these positions no longer fit in your investment plan and you can sell them with a low tax cost on the capital gain, consider selling these positions.
- If you have profitable investments that fit in your investment plan, or where selling would trigger large tax costs, keep these investments.
- Contact your new brokerage and ask them for proper instructions on requesting an "in-kind" position transfer to your new non-registered account. Make sure you specify you want an "in-kind" transfer.
- Complete an "in-kind" position transfer request to transfer any current investments and cash balances from your old brokerage account to your new account. This is generally done through the ATON system.
- Your transfer should be processed within a few days.
Do not transfer positions with a capital loss from a non-registered account to a registered account such as your RRSP. Take the capital loss first and use it to offset past or future capital gains. Then transfer cash to your registered account. Make sure you do not purchase essentially the same investment within 30 days to avoid triggering a superficial loss.
If you transfer positions with a capital gain from a non-registered account to a registered account, it will be considered a disposition of the asset. Although you are still holding the investment in a registered account, you will need to claim the capital gain effective on the date of the transfer when you file your income taxes.
Reducing Your Tax Costs
As stated earlier, you must claim and pay taxes on any realized investment income and realized capital gains every year for your non-registered investment account.
Taxes on investment income in non-registered investment accounts can broadly be categorized into two groups: distributed income and net realized capital gains.
There are effective strategies you can use to ensure your non-registered account remains tax efficient. This will maximize your net returns and improve your overall investment success.
Dividends are a long-established form of profit sharing for shareholders. They are payments regularly distributed to shareholders on a preset schedule. While the frequency varies by each corporation or ETF, they are generally paid monthly, quarterly, or annually and will go directly into your brokerage account unless you specify otherwise.
Dividends paid by foreign companies are not eligible for the dividend tax credit. This is because these corporations have not already paid corporate income tax to the Canadian government. As such, foreign dividends received by Canadian shareholders are taxed as regular income. However, you may deduct any withholding taxes on distributions that was collected by foreign governments. High yielding foreign company stocks—or ETFs which hold foreign stocks—should be avoided in your non-registered account.
Dividends paid by the vast majority of publicly traded Canadian corporations are eligible for the dividend tax credit. This is because dividends are paid to shareholders from a corporation's net income. The dividend tax credit is designed to offset the corporate tax already paid by the shareholders through their ownership stake in the company, essentially reducing double taxation on this distributed income. For the end investor this means dividends are taxed at very low tax rates. Depending on your income level and province of residence, taxes on dividends after the tax credit can be as low as -9.60% and as high as 42.61%. However, be careful about the implications that eligible dividends have on your benefits. Before the tax credit is applied, the dividends you receive are grossed up by 38% on your tax return making your income appear higher than it really is.
In general, if you earn a high income (above $95,000 per year) you do not want to hold investments which pay a high rate of dividends. The taxes you must pay will reduce your net investment returns quite substantially. Instead, choose low dividend stocks or stocks which do not pay dividends and that have a higher potential for capital gains returns.
If you earn a moderate income (between $47,000 and $95,000 per year) you should be careful about investing in high-yielding Canadian stocks. The dividends will be taxed at lower rates, but depending on your province it may still be advantageous to choose low yielding stocks and pursue capital gains returns instead.
Low income Canadians can benefit quite substantially from dividend income from Canadian corporations. Dividends at this income level are taxed at very low rates and, in certain provinces, are taxed at negative rates. However, the dividend tax credit and gross up calculation can impact certain retirement benefits.
Interest income is generally paid on loans. For a typical investor using a non-registered account, this includes income from bonds, bond ETFs, GICs, money market investments, and cash balances. In most of these investments interest is paid monthly or semi-annually.
Interest income is taxed as regular income at your marginal tax rate. Depending on your income and province of residence, you could pay tax rates as high as 54% on interest income. Since interest will often form the bulk of your returns in these investments, this is a significant penalty and will substantially reduce your investment returns.
You should try minimize or avoid earning interest income in your non-registered investment account. If you must use your non-registered account to invest in bonds, be sure to choose a tax efficient bond ETF. Currently there are tax efficient options available from Horizons ETF, CI First Asset ETF, and BMO ETF funds. Based on their designs and investment approach, these ETFs convert all of, or a part of, the interest returns into capital gains that are either deferred or distributed.
Return of Capital Income
Return of capital is a unique form of income that is typically distributed by real estate investment trusts (REITs) and ETFs. Although they are distributed as income, they are not really a true form of income. Instead, the trust or fund is returning your own money to you in the form of a distribution.
Return of capital is not taxed per se, instead these distributions are used to reduce the cost base of your investment. For example, if you purchased a fund for $50 per unit and that fund distributed $1 per unit as return of capital, your cost base on each unit is adjusted down to $49. Often just a portion of the total distributions is considered return of capital, be very careful to properly track return of capital distributions in your non-registered accounts and adjust your cost base.
Taxes on return of capital distributions come due when you sell your investment, or when the cost base on your investment is reduced to zero. At this point, you are taxed as a capital gain where only half the distribution is included as income and then taxed at your marginal income tax rate.
Return of capital distributions can be highly tax efficient for most Canadians. They are especially effective for retirees, including high income retirees. You may receive return of capital income every year for many years and pay no current taxes on that income. When the tax bill finally comes due, it may be through your estate.
Capital gains are the profits you earn when selling your investment for more than you paid for it (your sale value minus commissions minus your cost base). In certain investments, capital gains may be distributed as a straight capital gain or as return of capital, but this is generally reserved for real estate investment trusts (REITs) and a few ETFs.
Capital gains are taxed at very preferential tax rates. Under current law, investors are only taxed on half of their net realized capital gains each year at their marginal income tax rate. This means that capital gains are taxed at half, or less, of your regular income tax rate. While not always as attractive as Canadian dividend income for low income Canadians, capital gains are the most tax efficient form of investment return for everyone else.
Tax Loss Harvesting
To further reduce income taxes on capital gains, investors often use a strategy called tax loss harvesting. In this strategy, an investor who has sold investments for a capital gain will examine their portfolio near the end of December. They will look for any investments which are showing a loss. They will deliberately sell the investment for a loss and use that loss to offset capital gains they made earlier in the year.
There are some rules to be aware of. You may not sell an investment for a loss and repurchase an essentially identical investment within 30 days. This is called a "superficial loss". However, you can often find comparable substitute investments which are not essentially identical investments. For example, you can sell a Canadian large cap stock ETF for a loss, immediately purchase a Canadian all cap stock ETF, and still claim the capital loss. Or you might sell an investment in Bell Canada for a loss, immediately purchase shares of Telus, and still claim the capital loss.
Careful and creative use of tax loss harvesting can drastically improve your overall investment returns by reducing your tax bill.
Capital Gains Harvesting
Another effective strategy you can use to reduce long-term taxes on profitable investments is called capital gains harvesting. Unlike selling investments for a loss, superficial loss rules do not apply to selling investments for a gain. This means you can sell a part of a long-term investment for a gain and immediately repurchase those shares at the current higher price. This sounds counter-intuitive, but your repurchased shares will increase the cost base of your entire holding. The higher your cost base is, the less capital gains tax you will need to pay on future sales.
Capital gains harvesting is best done in a year where you earned a very low income, you sold investments earlier in the year for a loss, or you have capital losses on your tax return that were carried forward from previous years.
Be careful to size the transaction correctly. You do not want to end up paying a lot of income tax on your capital gains harvesting strategy. If you don't have capital losses to offset your gains, I would restrict capital gains harvesting to years when you are sure you will be in the lowest tax bracket for your province. This will cap your effective capital gains tax rate to 12% or less.
Margin and Borrowing Cost Deductions
Borrowing money to invest in your non-registered account can be an effective method to reduce overall tax costs while increasing portfolio gains. This strategy is certainly not without its risks. Whenever you borrow money to invest, you amplify the returns—both positive and negative—on your base equity. Leverage should always be done very carefully.
Under current Canadian tax law for interest and carrying costs deductions, you may deduct any costs related to loans where the proceeds are invested for the purpose of generating income. This includes interest costs, loan costs, and administrative fees related to the loan.
One of the benefits of interest and carrying costs deductions is these expenses can be used to reduce all kinds of taxable income: employment income, RRSP withdrawals, dividends, and so on at your marginal tax rate. There are also no rules specifying how much income must be earned in order to deduct the loan interest.
If you are a moderate to higher income Canadian , you can benefit substantially from borrowing to invest. You can take out a loan at a competitive rate of interest, place the proceeds in your non-registered account, and use the money to invest in Canadian stocks that pay a small dividend. It is even possible to invest in individual stocks which do not pay a dividend, as long as it is reasonable to expect the stock to pay a dividend at some point in the future.
This means you can capture the spread in tax rates between your marginal tax rate and dividend tax rates. You can also adjust your income lower and supplement your loan costs with your savings contributions. In addition, when properly invested and controlled for risk, you could have very high investment gains on your portfolio equity.
For example, you can obtain a CAD margin loan at Interactive Brokers for less than the bank prime rate (approximately 3% in 2019). This means you can deduct $3,000 from your top line income every year per $100,000 you have borrowed. You would then invest this money in a basket of individual Canadian stocks. Controlling for yield, you would be able to ensure your dividend yield averages 1%, or $1,000 per year per $100,000 you have invested. You would contribute the extra $2,000 per $100,000 borrowed that is required to cover the interest costs.
In Ontario, if you earn $75,000 per year at your job, you could save yourself $825 in income tax expenses for every $100,000 you borrow and invest in the method described above. With reinvestment of the tax savings, you can increase your portfolio's compounded return by more than 25% with minimal effort (after deducting loan costs). This boost is substantial over time.
There are several good methods you can use to borrow money for investment purposes.
- Obtaining a HELOC loan against equity in your home. Your borrowing rate should be no higher than Bank Prime Rate + 1%.
- Using a margin loan at a brokerage. Only use this method if the interest rate is equal to or lower than Bank Prime Rate + 1%. Do not leverage up more than 2:1 and be sure to carefully manage your investment risk.
- Borrow against your RRSP or TFSA with a non-arms length mortgage. I discuss this in more detail in my RRSP Guide and TFSA Guide. (A more advanced structure, but can provide additional benefits.)
Non-residents and Non-registered Accounts
If you have a non-registered investment account and you become a non-resident of Canada, you will likely have to close that account. In most situations you will need to open a new account at a brokerage that accommodates residents from your new country of residence. Interactive Brokers can be a very good option for many Canadian expats.
Becoming a non-resident can be an expensive process if you have substantial holdings in non-registered accounts. First, on the day you leave Canada all of your holdings in your non-registered account will be deemed as disposed at their fair market value. This doesn't mean you have to actually sell your investments, but you will be required to pay any outstanding net capital gains taxes owing on your holdings when you file your last tax return.
If you keep your Canadian investments as a non-resident, you will be subject to withholding taxes on distributions from those investments. The withholding tax rate can vary by country depending on the tax treaty, but the common rate is 10% to 15% on interest income and dividend income.
Once you have paid your taxes owing on your capital gains and you file your final tax return with the Canadian government, you are effectively free of Canadian taxation on your non-registered investments if you structure your holdings in the correct way.
You should begin by opening a new brokerage account outside of Canada. Since all your investments were deemed disposed and you have paid any taxes owed, you can start with a clean slate. Structure your investments to be as tax efficient as possible for your new country of residence. You should sell any Canadian investments which pay dividends or interest and focus on capital gains instead.
Although it's possible to keep your investment taxes relatively low in your non-registered account as a resident in Canada, many countries in the world—outside of western Europe—have much more favourable tax rates on investment income. Some charge no tax at all on investment income, many others charge low flat tax rates of 15% or less, and others only charge tax on certain forms of investment income that can be easily avoided with proper planning.
Dying with a Non-registered Account
When an individual dies, their property is deemed to be disposed immediately before their death. This means if the deceased person has a non-registered account with investments that have increased in value from their cost base, their estate will owe capital gains taxes on those investments. As usual, any capital gains may be offset by capital losses on investments which have declined in value from their cost base, or prior realized capital losses which have been carried forward.
If the estate has a net capital loss on current investments, the estate may use these losses to offset any capital gains which the deceased already paid taxes on in the prior three tax years. If there are no prior capital gains, the estate may use the net capital loss to offset certain types of other income.
The estate may avoid paying capital gains tax if the assets are transferred to the deceased's spouse or common-law partner upon death. In this event, the spouse would receive the assets at their original cost base into their own investment account.
The estate must also pay taxes on income declared, but not yet received immediately before death. This could include dividends, ETF distributions, bond interest payments, and so on.
Be sure to speak with an accountant and estate lawyer to ensure a smooth, tax-efficient estate process.