Many investors love Canadian dividends because they come with a tax break called the Dividend Tax Credit (DTC). Others look a little deeper and say that the DTC just prevents double taxation because the companies paying dividends already had to pay tax on their profits. They conclude that dividend income is no better than interest income, at least from a tax perspective. However, comparing the DTC to capital gains taxes gets more complex. Dividend Taxation in Canada The DTC is intended to prevent Canadian company profits paid to Canadian shareholders from getting taxed twice. Here’s an example to illustrate the idea: Suppose a company earns one dollar in profit per share, pays 27 cents in income taxes, and pays the remaining 73 cents in dividends to each shareholder. Canadian shareholders actually declare the full dollar as income (called the dividend gross-up), but they get to deduct the 27 cents from the taxes they owe. The idea is that the total tax paid by the company ...

Trying to maximize your after-tax retirement income is a complicated business. Cheerleaders for dividend investing are convinced that the dividend tax credit makes it a no-brainer that a dividend strategy is best to minimize taxes. However, as we’ll see, there are good strategies that use the 50% capital gains exemption as well. Let’s look at two investors in the same situation but using different investment strategies. Dean, the dividend investor, and Carla, the capital gain investor, are both 58 years old, single, and living in Ontario. (No, there will be no romance in this story.) They both have a $500,000 RRSP and $1,232,000 in a non-registered account. (I’ll explain this cooked-up number.) Dean owns dividend stocks that we’ll assume earn a 2% capital gain and 4% dividend each year. Dean’s dividend income is 4% of $1,232,000, or $49,280. This just happens to be the maximum he can earn and pay no taxes other than the $600 health premium. Carla earns the same total retu...

There are persistent myths about the tax-inefficiency of RRSPs. Here I debunk these myths using pictures. Myth 1: It is more tax-efficient to earn capital gains in a non-registered account than it is to earn them in an RRSP. A typical justification for this belief is that in a non-registered account only half of the capital gains are taxed, but all of an RRSP withdrawal gets taxed. To explain why this is a myth, let’s enlist the help of a hypothetical investor Ami. Five years ago Ami bought a house on her own and was somewhat house-poor until a promotion and raise two years ago. Since then she has managed to build $11,000 in a savings account without adding any debt beyond her mortgage. Ami plans to use $5000 of her savings toward a used car this summer, but she wants to invest the remaining $6000 for the long term. She is trying to choose among an RRSP, a TFSA, and a non-registered account. Within the account, Ami intends to invest with a goal of earning capital gains. ...

It seems to be conventional wisdom that once you start drawing from retirement accounts, your investments should be shifted into income generating assets such as bonds and dividend-paying equities. This makes little sense to me. Let’s consider an example. Suppose that Sam starts retirement with a million dollars in a tax-sheltered account. He invests in dividend-paying stocks and in the first year he makes $40,000 in dividends plus $60,000 in capital gains. He withdraws the cash dividends to live on and leaves the capital gains in the account. Another new retiree, Linda, invests her million dollars in non-dividend paying equities and makes $100,000 in capital gains in her first year of retirement. She sells $40,000 worth of stock to generate cash to live on. What’s the difference between these two cases? Not much. What matters are the returns you get and the risk you take to get these returns. In tax-sheltered accounts, the difference between capital gains and dividends isn’t i...

Do you still have some tech stocks lying around in your investment account from the boom days? Some of your stock positions might even be worth less than $100. What good could they possibly be now? The answer is that they might help out on your taxes. When you sell an investment for more than you paid for it, you have made a capital gain , and you will have to declare this gain on your taxes if it is not in a tax-sheltered account, like an IRA in the US or an RRSP in Canada. If you sell an investment for less than you paid for it, you have a capital loss . Fortunately, each year you pay taxes on your net capital gain, which means that you get to subtract all your losses from your gains. So, if you are going to have a net capital gain this year, you might consider selling one of those high-tech stinkers to create a capital loss to offset your capital gain. Take some time to think through all the relevant tax implications, though. For example, if your income is unusually low this yea...