Tax Deferral: Too much of a good thing?
Successful investors in the stock market know to let gains run by avoiding frequent trading that only hands over tax to the government, money that otherwise is available for investment. This deferral of capital gains tax is a smart decision that keeps money in your hands to compound returns over time, pushing out the tax liability far into the future.
If you have been following this approach for the past several years when stock market gains have been bountiful, you will likely have substantial unrealized capital gains in your investment account. But there does come a time when it can become too much of a good thing, as a growing capital gains tax bill begins to overwhelm the benefits of deferral.
Deferring tax is tax-efficient while you are young or in the early years of retirement, but as you enter the autumn of life two events can alter the equation.
A married couple can split income while both are alive, but when one dies, the survivor begins paying all the income tax assessed on the combined assets, loses the deductions of one spouse, likely moves into a higher tax bracket, and ends up paying more tax than was previously paid while both spouses were alive.
Large, unrealized capital gains are eventually taxed when the second spouse dies. All gains are deemed to be realized on death with the taxable gains added to the income of the estate, and, depending on the size, could push the estate marginal tax rate to the top tax rate.
What to do
Consider realizing capital gains gradually each year while both spouses are still alive if each person’s marginal tax rate will be less than would be the case in the estate. Starting when you turn 80 could leave enough years to complete the task. You can immediately buy the assets back again if you wish to continue to own them.
If you are in a low tax bracket, consider intentionally realizing enough capital gains to bring you up to the top of that tax bracket.
Watch for the OAS clawback threshold which for 2026 begins at a net income of $95,323 for each person. Beyond that each extra dollar of OAS received attracts an additional tax of 15% all the way up to a net income of $152,062. This clawback means your overall marginal tax rate will actually vary from 43.2% to 55.7% over the OAS clawback range, (using B.C. Provincial tax rates), significantly reducing the tax savings you are trying to achieve.
Bottom Line
Good tax and estate planning involves managing the rate at which you are taxed rather than when you are taxed.