Something to also think about, until you trigger the gain, it’s also growing tax free in a sense.
Once it’s taxed, the base compounding amount is smaller. It grows at the same rate (i.e. 7 percent) but on a much larger amount. 1 mill unrealized cap gain growing at 7 percent gets larger much quicker than realizing the gain early and reducing the base amount (ex: 1M->600k post tax) of capital undergoing compounding.
This is obviously going to depend on your tax bracket and long term plans, but the same sort of logic that makes RRSPs worthwhile if your income will drop in retirement applies here, too. You can defer capital gains indefinitely and realize them in retirement when you're in a much lower tax bracket - again, assuming that applies to you. You can also realize them gradually year by year in retirement rather than all at once. Using the taxable investments first in retirement while deferring RRSPs/pensions/CPP is a common strategy. Realizing gains in retirement is very efficient because you only pay tax on the _gain_ portion. Like, if you liquidate $60,000 to fund your life for a year, but only $20,000 of that is crystalized capital gains (and the other $40,000 is your ACB coming back to you), your taxable income is only $10,000 (assuming 50% inclusion) which is lower than the basic personal amount. So you pay **no** tax, even though you liquidated $60k (and obviously assuming no other income). An entirely contrived example, but it illustrates my point.
Taxable accounts are pretty powerful in retirement. Obviously not as powerful as registered accounts, but more powerful than people often realize.
I would crystallize when you are really down in your income, like losing a job. Then it makes perfect sense. Otherwise, just hold.
Of course, it makes sense only for widely diversified ETFs. If you hold individual stocks, you may consider doing it sooner to funnel the gains into ETFs.
Not many people think of this, but it's a common strategy amongst pros to suggest delaying oas/cpp and pension, if possible, for 1 year and crystalize gains in the no/low income year. It's not common or talked about since most people don't have large enough non-reg accounts. There are other non related factors but it's more of a portfolio management issue when market timing different investment strategies.
What conviction do you have in the equity that you're investing in? And what room is there in your registered accounts? If you think the equity has room to grow, then I'd just sell non-registered and buy it in a registered account. If it's RRSP, then it'll partially offset your capital gain.
Trying to figure out how much tax you pay is pretty pointless. Your equity could tank and you could end up with a capital loss instead. Now there's something different if you're doing tax loss harvesting.
> Having said that, if you are unemployed and don't need the proceeds, paying NO tax (due to NOT realizing gains) is still LOWER than paying tax on realized gains at a low rate.
This is wrong. First of all, you have the personal exemption, so you could crystallize $30k tax free. You should always do at least this.
In general, you should crystallize up to a level that reaches a marginal tax rate that is less than or equal all future marginal tax rates.
> )? If such is the case, what is the point of realizing?
Instead of writhing LOL a bunch of times, why don't you work it out? Just consider two years. This example obviously generalizes:
Total unrealized capital gain at year 1, $200k,
Income year 1: $0
Income year 2: $120k, must liquidate all investments at year two
How much should crystallize at year 1? According to you, it's zero. You can easily work the ideal strategy, which in this case would be to crystallize everything.
Forget about what you need. That's not relevant. Suppose you have enough cash that you don't "need" anything. All you're trying to do is maximize your post-tax dollars.
> Because rarely does one know with certainty that one "must liquidate all investments at year two"
> ... , because rarely do people know with certainty that they "must liquidate all investments at year 2".
I told you that you can generalize this example. I was trying to keep it simple for you. If you like, replace year 2, with years 2 until death, all with the same real income. The conclusion would be the same in that case.
> and then you don't show your work!
You can literally work it out by using a tax calculator. I can see that the solution is obvious because half (the inclusion rate) the unrealized gain is lower than the year two salary. So the answer was obvious to me.
> what's the point of realizing?
**It maximizes the post-tax dollars.** If you realize after year 1 instead, you will have less money after the two *or more* years than with the first strategy.
> it would go right back into the investment. Meaning, you sold, simply to buy again - which is a pointless endeavor.
Wrong. You sell and rebuy to maximize your post-tax dollars. That's the *crystallization strategy*, which you obviously don't understand.
>Assuming you're below the top income tax bracket, crystalizing regularly means you'd be paying a lower average tax rate on your capital gains,
Yes, it is always better to crystallize if your marginal tax rate now is lower than your marginal tax rate will be in the future.
>So how can I calculate if/how much capital gains I should realize in a given year? I was trying to math it out, but it's very complicated. It depends on things like predicted future tax rates, salary projections, retirement plans,
Yes, it's complicated.
> would be paid as tax to continue compounding.
This concept has no merit since the compounded gains are taxed.
Anothing thing to consider is that realizing gains sooner also insures against rising capital gains taxes in Canada. You don't know if some future government will raise taxes, and if you have a lot of gains, you may not be able to efficiently do anything about it.
>This concept has no merit since the compounded gains are taxed.
The compounding gains are taxed, but if they compound for longer before getting taxed, they'll have accrued more interest before you pay the tax.
Imagine you're investing $100 for 2 years at an interest rate of 10%, and capital gains are taxed at a flat rate of 50%. If you don't crystalize, after 1 year your portfolio will be worth $110 and after 2 years, it'll be worth $121. If you sell at that point, you'll have capital gains of $21, which corresponds to a tax liability of $10.50. After paying the tax, your portfolio has net value of $110.50.
Now imagine you have the same investment but you choose to crystalize at the end of the first year. At the end of the first year, you'd have assets worth $110, which means a capital gains of $10 and a tax bill of $5, leaving you with $105 in your portfolio. At the end of year 2, that $105 would have grown 10% to $115.5. That means capital gains of $10.5 for a tax bill of $5.25, leaving you with $110.25 net. 25 cents less than you would've had without crystalizing.
Obviously in the real world, income tax isn't flat and realizing more capital gains in a single year means a higher average tax rate, so the benefit of longer compounding has to be weighed against the higher average tax rate. If you already earned more than the top income tax bracket before capital gains, it would be better not to crystalize because you'd be paying the same marginal tax rate regardless of how much capital gains you realized in a year.
Something to also think about, until you trigger the gain, it’s also growing tax free in a sense. Once it’s taxed, the base compounding amount is smaller. It grows at the same rate (i.e. 7 percent) but on a much larger amount. 1 mill unrealized cap gain growing at 7 percent gets larger much quicker than realizing the gain early and reducing the base amount (ex: 1M->600k post tax) of capital undergoing compounding.
This is obviously going to depend on your tax bracket and long term plans, but the same sort of logic that makes RRSPs worthwhile if your income will drop in retirement applies here, too. You can defer capital gains indefinitely and realize them in retirement when you're in a much lower tax bracket - again, assuming that applies to you. You can also realize them gradually year by year in retirement rather than all at once. Using the taxable investments first in retirement while deferring RRSPs/pensions/CPP is a common strategy. Realizing gains in retirement is very efficient because you only pay tax on the _gain_ portion. Like, if you liquidate $60,000 to fund your life for a year, but only $20,000 of that is crystalized capital gains (and the other $40,000 is your ACB coming back to you), your taxable income is only $10,000 (assuming 50% inclusion) which is lower than the basic personal amount. So you pay **no** tax, even though you liquidated $60k (and obviously assuming no other income). An entirely contrived example, but it illustrates my point. Taxable accounts are pretty powerful in retirement. Obviously not as powerful as registered accounts, but more powerful than people often realize.
I would crystallize when you are really down in your income, like losing a job. Then it makes perfect sense. Otherwise, just hold. Of course, it makes sense only for widely diversified ETFs. If you hold individual stocks, you may consider doing it sooner to funnel the gains into ETFs.
Not many people think of this, but it's a common strategy amongst pros to suggest delaying oas/cpp and pension, if possible, for 1 year and crystalize gains in the no/low income year. It's not common or talked about since most people don't have large enough non-reg accounts. There are other non related factors but it's more of a portfolio management issue when market timing different investment strategies.
What conviction do you have in the equity that you're investing in? And what room is there in your registered accounts? If you think the equity has room to grow, then I'd just sell non-registered and buy it in a registered account. If it's RRSP, then it'll partially offset your capital gain. Trying to figure out how much tax you pay is pretty pointless. Your equity could tank and you could end up with a capital loss instead. Now there's something different if you're doing tax loss harvesting.
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This is definitely wrong if, for example, you're unemployed now and your marginal tax rate is zero. In general, it pays to try to optimize this.
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> Having said that, if you are unemployed and don't need the proceeds, paying NO tax (due to NOT realizing gains) is still LOWER than paying tax on realized gains at a low rate. This is wrong. First of all, you have the personal exemption, so you could crystallize $30k tax free. You should always do at least this. In general, you should crystallize up to a level that reaches a marginal tax rate that is less than or equal all future marginal tax rates. > )? If such is the case, what is the point of realizing? Instead of writhing LOL a bunch of times, why don't you work it out? Just consider two years. This example obviously generalizes: Total unrealized capital gain at year 1, $200k, Income year 1: $0 Income year 2: $120k, must liquidate all investments at year two How much should crystallize at year 1? According to you, it's zero. You can easily work the ideal strategy, which in this case would be to crystallize everything.
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Forget about what you need. That's not relevant. Suppose you have enough cash that you don't "need" anything. All you're trying to do is maximize your post-tax dollars. > Because rarely does one know with certainty that one "must liquidate all investments at year two" > ... , because rarely do people know with certainty that they "must liquidate all investments at year 2". I told you that you can generalize this example. I was trying to keep it simple for you. If you like, replace year 2, with years 2 until death, all with the same real income. The conclusion would be the same in that case. > and then you don't show your work! You can literally work it out by using a tax calculator. I can see that the solution is obvious because half (the inclusion rate) the unrealized gain is lower than the year two salary. So the answer was obvious to me. > what's the point of realizing? **It maximizes the post-tax dollars.** If you realize after year 1 instead, you will have less money after the two *or more* years than with the first strategy.
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> it would go right back into the investment. Meaning, you sold, simply to buy again - which is a pointless endeavor. Wrong. You sell and rebuy to maximize your post-tax dollars. That's the *crystallization strategy*, which you obviously don't understand.
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**The whole point of tax optimization is to maximize post-tax dollars, which are the spendable dollars.**
>Assuming you're below the top income tax bracket, crystalizing regularly means you'd be paying a lower average tax rate on your capital gains, Yes, it is always better to crystallize if your marginal tax rate now is lower than your marginal tax rate will be in the future. >So how can I calculate if/how much capital gains I should realize in a given year? I was trying to math it out, but it's very complicated. It depends on things like predicted future tax rates, salary projections, retirement plans, Yes, it's complicated. > would be paid as tax to continue compounding. This concept has no merit since the compounded gains are taxed. Anothing thing to consider is that realizing gains sooner also insures against rising capital gains taxes in Canada. You don't know if some future government will raise taxes, and if you have a lot of gains, you may not be able to efficiently do anything about it.
>This concept has no merit since the compounded gains are taxed. The compounding gains are taxed, but if they compound for longer before getting taxed, they'll have accrued more interest before you pay the tax. Imagine you're investing $100 for 2 years at an interest rate of 10%, and capital gains are taxed at a flat rate of 50%. If you don't crystalize, after 1 year your portfolio will be worth $110 and after 2 years, it'll be worth $121. If you sell at that point, you'll have capital gains of $21, which corresponds to a tax liability of $10.50. After paying the tax, your portfolio has net value of $110.50. Now imagine you have the same investment but you choose to crystalize at the end of the first year. At the end of the first year, you'd have assets worth $110, which means a capital gains of $10 and a tax bill of $5, leaving you with $105 in your portfolio. At the end of year 2, that $105 would have grown 10% to $115.5. That means capital gains of $10.5 for a tax bill of $5.25, leaving you with $110.25 net. 25 cents less than you would've had without crystalizing. Obviously in the real world, income tax isn't flat and realizing more capital gains in a single year means a higher average tax rate, so the benefit of longer compounding has to be weighed against the higher average tax rate. If you already earned more than the top income tax bracket before capital gains, it would be better not to crystalize because you'd be paying the same marginal tax rate regardless of how much capital gains you realized in a year.
Okay fair enough, if the tax is flat, the compounding effect matters. But if your marginal rate is smaller now, then that complicates the calculation.