What is tax loss harvesting?
Tax loss harvesting is a strategy that uses investment losses to create tax savings. The idea is to purposely sell investments that have gone down in value so that you realize losses on investments in order to save money on your taxes. It's only available to Wealthsimple Black clients and only makes sense in a few circumstances. It's a little complicated, so you may want to read up on our Investing 101 page.
When tax loss harvesting doesn't make sense
To understand why tax loss harvesting doesn't always make sense, let's pretend you're a Wealthsimple Black client and when you start investing you:
- Are an Ontario resident
- Have an annual taxable income of $80,000
- Invest $100,000 in a Personal (non-registered) account
Each year, your income grows by 6.4%, the market returns 4% on your investment, and Wealthsimple's automated system harvests (sells off) $3,000 worth of losses from your portfolio. After five years, you decide to sell your portfolio. Now:
- Your annual taxable income is $110,000 (putting you in a higher tax bracket)
- Since you've been selling off $3,000 from your portfolio each year, ($15,000 over 5 years) the cost of your investment is $85,000 ($100,000-$15,000)
When you pay taxes on your investment gains, you're paying the difference between what your portfolio is worth and what you bought it for. Instead of paying taxes on the value of your portfolio (remember, it's gone up each year) minus $100,000, you have to pay taxes on your portfolio minus $85,000.
You're now paying taxes on $15,000 of additional gains. Since your income has increased, you'll be paying a higher capital gains tax rate than you would have at $80,000 of income.
Deferring taxes rather than paying them on the spot means you've been able to keep funds invested, benefitting from the magic of compounding returns. That's the primary benefit of tax loss harvesting. At 2017 tax rates, you would have benefitted to the tune of $3,017.14 by using tax loss harvesting. The taxes payable would amount to $3,255.00, leaving you about $237.86 worst off than if you hadn't employed tax loss harvesting.
OK, so when should I use tax loss harvesting?
Tax loss harvesting is generally the right strategy for your portfolio if:
- Your annual income is above $100,000
- You don't plan on making a large withdrawal in the next 12 months
- You're invested in a non-registered account
Note that if you turn on tax loss harvesting, this will not impact your registered accounts e.g. RRSP, TFSA.
If you're not sure if tax loss harvesting is the right strategy for your portfolio, get in touch at email@example.com and one of our experienced portfolio managers will help you figure it out.