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How to Optimize Dividend Income Tax!

A little while ago, I wrote about investing taxes in Canada (Part 1, Part 2). These articles drew quite a few questions from my readers which actually got me thinking quite a bit.

In the article “How Investing Taxes Work – Part 2 Dividends and Interest”, I suggested that dividend income should be kept OUTSIDE your registered account due to the dividend tax credit that you receive. This is not entirely true. Here is a quote from a financial expert, Norbert, on FinancialWebRing:

… the RRSP will still be better for dividend payers if you are in a tax bracket where the marginal rate on dividends is > 0. In most provinces, that means you have to be in the second bracket, i.e. have a taxable income over $35k. In BC, which did the right thing by its dividend collectors, you have to be in the third bracket (taxable income over ~$70k) before there is much advantage from using the RRSP to catch dividends.

Currently, it is more efficient to keep your dividends outside your registered account ONLY if you are a low income earner (except BC). How low do you ask?

Below is a table that I created by province and maximum income earned before it is more efficient to hold your dividend paying assets inside your RRSP. Also note that your dividend income is grossed up by 45% which is then added to your employment income to figure out your marginal rate and whether or not you fall under the maximum income. Mind you that these numbers are based on tax law today and probably won’t be the case in a couple years with our ever changing tax landscape.

Updated Aug 2009

Province Maximum Income
NL $40,726
NS $29,590
PE $40,726
NB $40,726
QU taxed from $1
ON $40,726
MB $40,726
SK $40,726
AB $40,726
BC $71,433

For me personally (in Newfoundland), as it stands right now, it would be more efficient for me to keep my dividends INSIDE my RRSP. With my growing employment income even the enhanced dividend tax credit will not beat the tax free growth offered by my RRSP. If you look at the table, it’s apparent that anyone investing in dividends should move to BC. :) In BC, you can earn up to $71,433 in employment income + grossed up dividends before you pay ANY tax on your dividend income.

Are you confused yet? To be completely honest, I’m a little fuzzy headed right now too! As you can probably tell, I’m the type of person who seeks to OPTIMIZE everything. This analysis is tricky as there are many variables to consider, like if I wanted to retire early, or if I started a business, or if my wife decides to become a stay at home mom. Each one of these scenarios should be planned differently.

In summary:

It is most efficient for high income earners (check table) to keep their dividends INSIDE their RRSP and for low income earners to keep their dividends OUTSIDE their RRSP. As a side note, it may not be the best strategy for a low income earner to even use an RRSP but that analysis is for another day.

If you would like to do your own tax calculations, go to taxtips.ca, choose your province, then select the “Tax and RRSP Savings Calculator”.

That’s all for now! Have a happy Monday!

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27 Comments

  1. canadian dollars on February 5, 2007 at 4:59 pm

    Thanks for the post. I had no idea that BC had such a policy. As a person living in ON it seems in my situation it makes sense to keep my dividend paying investments in my RRSP.

  2. Investor on February 13, 2007 at 1:07 am

    Intersting article, I have a very different perception I guess.. Good to know that.

  3. […] How to Optimize Dividend Income Tax – this is Canadian based, but an important reminder of the tax efficiency of dividend income. Why would a company make drastic cuts to its dividend payments A good reminder by Investopedia on why a true dividend investor would avoid stocks that have cut dividends – it is usually a real bad sign. Dividends are superior to interest – this applies to both Canadians and US investors – dividends are taxed way more efficiently Reuters Income Stock Screener – a good way to develop a list of prospects based on good fundamentals and dividend growth […]

  4. […] Your passive income strategy would depend on if you expect your income to increase over the years. In Calgary, you can make up to $37100 in employment AND dividend income without paying ANY tax on the dividends. Perhaps starting a non-registered portfolio would be a good idea based on Canadian dividend paying stocks. Since you make $35K, you can make up to $1,448/year in dividends (before gross up) without paying ANY tax on them. […]

  5. […] How to Optimize Dividend Income Tax […]

  6. RRSP Meltdown Strategy | Million Dollar Journey on September 17, 2007 at 5:02 am

    […] you are in a lower tax bracket, thus having a dividend based non-registered portfolio would be very tax efficient.  Note that if you have a very large dividend based portfolio, it may affect your Old Age […]

  7. Konstantin on September 18, 2007 at 2:26 pm

    FT,

    I am reading your blog regularly.
    Awesome resource!

    I would to ask all of you guys:
    I was wondering if you have 100% stocks that are dividend paying in your RRSP and you make RRSP withdrawals during the year – are they treated by CRA as dividend payouts (favourable tax treatment) or the default RRSP withdrawals tax schedule (10%, 20%, 30% withholding tax) applies?
    Or if it applies, will you have any tax refund come tax-time?

    Thank you for your responses.

  8. FrugalTrader on September 18, 2007 at 2:30 pm

    Konstantin, thanks for stopping by and for the compliments.

    ANY withdrawals from an RRSP is treated as income, thus taxed at your marginal rate.

    Depending on which province you’re from and the tax bracket that you’re in, it may be more tax efficient to keep your dividends outside your RRSP.

  9. Cannon_fodder on September 18, 2007 at 2:34 pm

    Konstantin,

    The CRA will take the withholding tax and deem any withdrawals as income at your marginal tax rate no matter if that withdrawal was due to a dividend payout, interest on bonds, stock sold for a capital gain or loss, etc.

    Look for the very recent RRSP Meltdown entry for discussion on how to withdraw from the RRSP tax free.

  10. Konstantin on September 18, 2007 at 4:47 pm

    FT /C_F,

    Thank you guys!

  11. Adam Soltys on November 26, 2007 at 3:30 am

    […] my RRSP this year and put any leftover cash into dividend paying stocks to take advantage of the dividend tax credit which is especially attractive to us British Columbians. So today I filled out applications for two […]

  12. FinancialJungle.com on January 9, 2008 at 4:20 pm

    I was in the middle of writing a piece on dividend tax credit, and then stumbled on this great post of yours. Well, I’ll probably just finish mine anyway even if it’s redundant.

  13. […] note that Newfoundland has the highest dividend tax around, so if you are living in BC or other dividend favorable province, you'll most likely turn cash flow positive […]

  14. newbie on January 15, 2008 at 8:37 pm

    I am having trouble understand the taxtips charts. Can someone tell me where would NT fit in this if you have two income family with one high (eg. 73 thousand), and one low (say 15 thousand).

  15. FrugalTrader on January 15, 2008 at 8:49 pm

    newbie, this is the tax tips chart for NT:
    http://www.taxtips.ca/marginaltaxrates.htm

    As you can see from the chart, someone making 73k in NT would pay around 5.41% in taxes on their dividends received for that year. NT is actually very favorable for dividend investors (taxation wise).

  16. newbie on January 16, 2008 at 12:59 am

    so that makes it better outside of rsps?

  17. newbie on January 16, 2008 at 1:13 am

    just to clarify: in NT would it be better in a couple for the low end earner (15 thousand) to do the dividend investment inside or outside a split spousal rsps, (i’m assuming outside by what you’ve said), or for the couple if the spouse with the high end income (73 thousand) puts dividends outside/inside? by that I mean if there is a split spousal rsp, would there be any benefit to the the higher wage earner having an additional rsp just for dividends, if that’s even possible?

    or to simplify (because i’m even confusing myself), who should do what where?

    • FrugalTrader on January 16, 2008 at 11:07 am

      newbie, if you plan on staying in NT for your working careers, then there is some tax benefit of keeping your dividends outside of an RRSP. However, you need to keep in mind the big picture. If you have kids etc, the extra income added onto the low income earner will reduce the child benefit from the government. If I were you, I would contact a GOOD accountant to see what the best scenario would be.

  18. newbie on January 17, 2008 at 4:59 pm

    Good advice… we’ll have to start looking around for one. Our taxes may start getting complicated as I am self employed, so it makes sense. I think the wealthy barber even recommends professional help. I think I’ll understand investing long before I can make sense of tax documents. I consider my hubbie a genius in so many ways and he has a head for numbers (he works with them for a living, never needs a calculator and works things out to the penny in the grocery store), but even he seems confused by taxation.

  19. YJ on January 11, 2009 at 2:09 pm

    Hi FT, Thanks for the great postings!

    I live in BC and am looking at the table in the link: http://www.taxtips.ca/marginaltaxrates.htm#BC

    Q1. I am making about $50K. The table says -0.38% for Eligible
    Dividends (Canadian Dividends) for my income bracket. So how did you get $68700 for BC?

    Q2. Are all Canadian stocks paying that pay dividends in TSX Eligible
    Dividends?

    Thanks,

  20. […] not as simple as getting $57k in tax free dividends in Ontario. I’ve written about how to optimize dividend income tax before and the table indicated in the article is the maximum that you can earn INCLUDING your […]

  21. Big Cajun Man on August 21, 2009 at 9:51 am

    Can you post an updated version of this table for 2009 or is it still mostly true?

  22. FrugalTrader on August 21, 2009 at 10:07 am

    BCM, there are changes to be made to this post, stay tuned!

  23. KK on September 2, 2010 at 8:29 am

    Hi FT,

    Would you please update the table with the 2010 numbers?

    Thanks!

  24. FrugalTrader on September 2, 2010 at 8:37 pm

    @KK, thanks for the idea, I will update the data and report in the near future.

  25. Showtime on November 27, 2010 at 2:12 am

    I read the article but I’m stil not sure what’s best for me, mainly because I’m thinking about using tfsa, not rrsp. I plan on using borrowed money to invest in something that will bear dividends eg REITS, dividend stocks, funds/trusts, etc. Would it be better to hold this in a tfsa or a regular non-tax sheltered acct? TFSA is tax-free. But w/ regular acct, there is the dividend tax credit and deduction for borrowing money to invest. I’m hoping that someone w/ a better understanding of rules and math can help me out w/ this. Using average/typical numbers, which method is better financially? If it helps w/ the calculation, my gross/pre-tax employment income is about $76k/year. BTW, is the dividend tax credit applicable to all the investments I mentioned, including REITs? Thx.

    • FrugalTrader on November 27, 2010 at 9:34 am

      @showtime, imo, you’re better off using real savings to fund your TFSA. Do you have a defined benefit pension with work? Why aren’t you using your RRSP? As to your last question, here is an article about how income trusts taxation works.

  26. Showtime on November 27, 2010 at 8:52 pm

    FT, thx for the reply and link. Some more background info about my situation may clarify.
    – I have a work pension, an ok amount in rrsp, a miniscule amount in tfsa, zero in cash/margin acct.
    – I have no true liquid cash savings (by my definition). After expenses, rrsp contrib, and tfsa contrib, any extra cash is stored in heloc ie to pay down debt. Of course I have cash for the occasional discretionary expense.
    – I’m paying off a mortgage at 3% and a large heloc balance at 4% (current nums). If I borrowed to invest, it would be from heloc.
    – I am making concerted efforts to pay down debt but am exploring the possibility that I can still make investment profit even after factoring taxes and borrowing interest to invest. (Agree or disagree?)
    – I am looking at stocks/trusts that pay monthly distributions. I would use the distribs to either reinvest or pay down debt.
    – I’m looking to be well-rounded and cover my bases, that’s why thinking of using tfsa and not rrsp, since i have much more in rrsp than tfsa.

    So now I’m thinking of holding assets in cash/margin acct and tfsa (both), depending on the type of distribs. Is this strategy sound or do you have other thoughts and recommendations? Thx.

  27. FrugalTrader on November 27, 2010 at 10:18 pm

    @showtime, what you are proposing is a leveraged investment strategy which is suited for those with high risk tolerance. Here is an article that may help you decide: https://milliondollarjourney.com/should-i-start-the-smith-manoeuvre.htm

    As well, it appears that you are using your HELOC for personal use, and intend to use it for investments as well. From my conversations with accountants, it is recommended to keep yoru personal and investment borrowing separate. To do this, you’ll have to contact your bank to see if you can get sub accounts within your HELOC.

  28. Marcus on August 19, 2014 at 2:13 pm

    Can I get a explanation and/or a rough calculation on why it is so about the maximum provincial incomes?

    I am not understanding why you don’t pay ANY taxes up to a certain threshold

    • FrugalTrader on August 19, 2014 at 3:00 pm

      @Marcus, it is assuming that you have no other income (besides dividend income). Basically the dividend income is offset by the basic personal amount, and the dividend tax credit. The tax deductions will result in $0 tax payable up to a certain point.

  29. Andrew on September 24, 2017 at 1:04 pm

    Hey, recently started reading your blog and i am starting from the beginning so you may expalin this in a future post but I am still a little unclear on why it is better to keep your dividend paying stocks in a RRSP? Is the assumption that you reinvest these dividends to grow your pool than withdraw when you lose your working income to lower your tax bracket?

    Also how does this fit into your financial freedom goal? If you are quiting work and relying on your passive income from dividends wouldnt you want this money in a non-registered account to get the tax relief?

    Where does TFSA accounts fit into this? Is it not recommended to have dividend stocks in TFSA?

  30. New Reader on September 24, 2017 at 1:05 pm

    Hey, recently started reading your blog and i am starting from the beginning so you may expalin this in a future post but I am still a little unclear on why it is better to keep your dividend paying stocks in a RRSP? Is the assumption that you reinvest these dividends to grow your pool than withdraw when you lose your working income to lower your tax bracket?

    Also how does this fit into your financial freedom goal? If you are quiting work and relying on your passive income from dividends wouldnt you want this money in a non-registered account to get the tax relief?

    Where does TFSA accounts fit into this? Is it not recommended to have dividend stocks in TFSA?

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