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 lose money on your 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, so $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 if for. So now, 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.
So you're paying taxes on $15,000 of additional gains. And since your income has increased, you'll be paying a higher capital gains tax rate than you would have at $80,000 of income.
On the upside, since you've gotten to defer taxes rather than pay them on the spot it means you've gotten to keep those funds invested and have benefitted from the magic of compounding. That's the whole 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. But, the taxes you would have to pay would amount to $3,255.00 - leaving you about $237.86 poorer 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 firstname.lastname@example.org and one of our experienced portfolio managers will help you figure it out.