The article “Should you withdraw from non-registered or TFSA investments in retirement?” was originally published in MoneySense on March 8, 2023 . Photo by Greta Hoffman from Pexels.

When starting to draw down your investments in retirement, should you sell your non-registered or TFSA stocks, or both?

“I have stocks in my TFSA as well as some that are non-registered. I am at the point in my life (retired) now that I’d like to begin selling them and using the money. Do I sell from the TFSA account or just from the non-registered portfolio?” Catherine

TFSA versus non-registered withdrawals in retirement

Great question, Catherine. And like many of my answers, I would say it depends. First, a primer on how stocks are taxed.

How dividends are taxed

In a non-registered account, dividends are taxable each year, whether you withdraw them from the account or not. This includes reinvested dividends in a dividend reinvestment plan (DRIP).

The way dividends from Canadian stocks are taxed is a bit weird. If your income is low, they can actually save you tax. For an Ontario taxpayer with under $49,000 of income in 2023, for example, the tax rate is about minus 7%, after accounting for the Ontario dividend tax credit. So, for every dollar of Canadian eligible dividends, you can save around 7 cents of tax that would otherwise be payable. Only six out of the 13 provinces and territories have any tax payable on Canadian stock dividends for a 2023 income of $49,000 or less.

Foreign dividends are taxable at a higher tax rate, as is interest income from bonds and guaranteed investment certificates (GICs). At the same $49,000 of income, for example, the next dollar of foreign dividend or interest income would be taxed at between 19% and 30%, depending on where you live.

How capital gains are taxed

Capital gains are only 50% taxable. That is, only half of a capital gain is reported as taxable income on your tax return. So, at the same $49,000 of taxable income, a $1 capital gain is taxable at between 10% and 15%, based on your location.

At higher incomes, Canadian dividends can be taxed at up to 42%, foreign dividends and interest can be taxed at up to 54%, and capital gains can be taxed at up to 27%.

Tax treatment of your TFSA

If you have cash and you have room in your tax-free savings account (TFSA), it makes sense to contribute to a TFSA at all levels of income (ignoring the room in your registered retirement savings plan, or RRSP, and potential debt repayment). If you have the option of using cash for an expense and keeping your TFSA investments, it is probably advantageous.

The only tax payable on TFSA income may be withholding tax on dividends. Foreign dividends generally have 15% withholding tax in a TFSA. All other income, including capital gains, is tax-free.

So, which should you choose: TFSA or non-registered withdrawals?

It can get a bit tricky if you have a non-registered portfolio with large deferred capital gains and you also have investments in your TFSA, Catherine. Selling your stocks in your non-registered account can trigger capital gains.

Let’s say you are a high-income retiree with $10,000 of stocks purchased for $5,000. If you sold the stocks for a $5,000 capital gain, the tax payable might be $1,250 (assuming taxes of 25%). If the alternative was a tax-free TFSA withdrawal, that might seem like the better option at first. However, taking an equivalent $8,750 withdrawal from your TFSA—to yield the same $8,750 after tax as the $10,000 non-registered stock sale—gives up future tax savings in that TFSA.

If we consider a Canadian stock paying a 2.5% dividend, the annual tax savings in a TFSA might be $87.50 (for the same high-income retiree, assuming 40% tax on Canadian dividends). Is it worth paying $1,250 in capital gains tax today to sell the non-registered stocks to save $87.50 per year of tax on dividends in a TFSA?

The dividend tax savings are not the whole story, though. If we assume 4% capital growth for the stock, there may be another $87.50 of deferred capital gains tax saved per year. Is it worth paying $1,250 in tax today to save $87.50 of tax per year and $87.50 of deferred tax per year?

It bears mentioning the $87.50 of dividend tax saving and $87.50 of deferred capital gains tax saving will compound over time. And a dollar of tax saved today is more valuable than a dollar saved in 10 years due to the time value of money. So, the math is not as simple as calculating that, after eight years, there will be more tax saved by keeping the TFSA stock invested.

Some general rules to follow

There may be a break-even calculation depending on a ton of different factors, Catherine, including:

  • Your current and future tax rates
  • Your investment risk tolerance
  • Your age
  • Your life expectancy
  • Your spouse’s life expectancy

As a rule of thumb, I would consider non-registered withdrawals over TFSA withdrawals under the following circumstances:

  • You are in a high tax bracket.
  • You could be in a higher tax bracket in the future.
  • You or your investment advisor frequently sell and repurchase stocks.
  • You have cash in your non-registered account.
  • You have modest capital gains in your non-registered account.
  • You are relatively young.
  • You have a relatively long life expectancy.
  • You have a spouse with a relatively long life expectancy.

Final thoughts

Ultimately, there are no perfect decumulation rules in retirement, Catherine, and you need to consider a bunch of factors. Using financial planning software, you can try to model different scenarios to see the potential impact on after-tax retirement income and after-tax estate value.

In some cases, taking TFSA withdrawals over non-registered withdrawals may make sense, especially if you have large deferred capital gains on your non-registered investments. Deferring those capital gains at all costs could be the wrong choice, though, especially if it means having concentrated positions in only a few stocks, which makes your portfolio less diversified. So, tap your TFSA and defer your non-registered capital gains tax cautiously, if at all.

Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.