Wednesday, April 22, 2009

outside of the box income

Want to make your neighbour or brother-in-law's head spin?

Right around this time of year is an absolutely perfect time to mention to someone that eligible dividends from Canadian Corporations attract a tax rate of only 6.9% if you live in Ontario. If you happen to live in BC or Alberta that rate gets even better at 4.4%. This is assuming that one earns $55,000 in total taxable income.

This compares with employment income which draws an average tax rate of about 20% in these provinces and a marginal (last dollar) rate of about 30%.

The only problem is that if you would like to earn dividends totalling a net amount of $44,000, as you would in employment income, you would need a portfolio valued at about $945,000. That being said, dividend income can provide a very good supplement to employment income as you go through your career and can be relied on more and more as you grow your portfolio.



approx. 1 million dollars
$850 00 invested in 10 year laddered corporate/provincial bonds
current avg. yield=4.7%
=$39 950
$150 000 invested in dividend-enhanced tax credit paying securities
current avg. yield= 7.5%
=$11 250

total earnings
=$51 200 - (avg. tax rate of 15.1%= $7 746)
= $43 454

not much difference in actual cash returned to you after tax, completely different exposure to risk and capital loss. as 85% of your capital is promised to be returned. It's also completely possible to build and keep the fixed-income portfolio in an RRSP during employed years.
when you are retired and hoping to live off about 40-50 thousand a year, your income will no longer be in an upper-income tax bracket. therefore the need to take on excessive tax-incentive based investments is unnecessary to achieve 'head-spinning' yield. less tax and lots of money, not bad for a millionaire.
IMO it's easy to believe that equities provide the optimal form of return on capital and growth. It's harder to not be greedy, to focus first and primarily on capital preservation and be willing to accept less upside. I suppose it's what works best for the individual investor, but if I work hard and retire with 945 000 dollars I'd sure like to know that half (or all) of it can't randomly evaporate.

you are absolutely correct that dividends makes sense for those currently employed and earning a salary that puts them in a higher tax-bracket. preferred shares are a relatively secure way to achieve some extra tax relief while working away the hours.
bank preferred shares yield about 6.5% now.

Fabulously Broke said...

If only it were true in Quebec. Everything is so weird here in laws and taxes.

Traciatim said...

Please keep in mind that if you have kids the way the dividend credit is calculated may effect your CCTB benefits, which could effect your actual return. Also, the same thing happens with other income tested benefits that use line 236 of your income tax form, like GIS for low income seniors, to base their decisions on.

It's not going to change the fact that dividends are a great way to earn income, but it's something that needs to be thought about when comparing returns.

For example, a single income family with 2 kids 7-18 years old earning 55000 in Ontario pays 8266 in tax, would receive 160.78 a month in CCTB (1929.36).

If you made $1000 in dividends your line 236 goes up $1450.
If you made $1000 in interest your line 236 goes up $1000.
If you made $1000 in capital gains line 236 goes up $500.

This would make your CCTB drop by $57.96, $39.96, and $20.04 respectively. Also, you tax bill would increase by $70, $312, and $156 respectively. So if you are figuring it out of final money received you end up:

Dividends: $1000 - 70 - 57.96 = $872.04.
Interest: $1000 - 312 - 39.96 = $648.04.
Capital Gains: $1000 - 156 - 20.04 = $823.96.

If you made 5% return originally in each case to get your $1000 you would have invested $20000, so your real after tax/benefit loss return ends up being 4.36% for dividends, 3.24% for interest, and 4.12% for capital gains.

The situation is much worse if you are getting clawed back 50% on the dollar receiving GIS.

Like I said, nothing major, but something to think about.


"Render unto Caesar that which is Caesar's".

that's my philosophy. the only sure things in life are death and taxes, and it's silly trying to avoid either. But if you're a millionaire, worked hard, probably have some life insurance, you can pay for all your taxes.
think about your kids finding you and your spouse dead and they have to deal with that and they're young and still need to go to school and your insurance helps replace your income, but your investments have been evaporated by half. If the market doesn't rebound your kids could hopefully still afford university, but after that it's likely they would have little or no inheritance left.

which is a worse scenario for the dead millionaire?

1)life insurance money being eaten up by maybe 1.5%-5% increase in the taxes on your estate,


2) NEVER knowing if the principal of your savings and investments will ever be returned to you or your dependents just on the one hope that you don't have to pay the government more money when you die?

i strongly believe that it is absolutely something major to consider.

Anonymous said...

Let's not forget dividend growth. Sure bonds are "safe", and "less risky" (not really, bond prices fluctuate also).
As dividends increase, so too will the stock price, usually in line with the dividend increase rate.
My RSP/TFSA are all 100% stocks. Sure I "lost" almost 50% of my portfolio value, but prices are coming back. More importantly my dividend has gone up. Since I invest for a growing income I can say that I have NEVER "lost" money. Each and every year my dividend income grows.


dear anonymous,
as long as your are comfortable with your 'loss', than i hope you remain confident.
a laddered portfolio provides regular opportunities to seek higher yield, similar to the 'growth' of your dividends. the difference primarily is that dividends are not promised to be paid (though depending on the company, still reliable) and i am promised the quoted yield at the time of purchase until maturity.

Anonymous said...

You are also "promised" to more than likely not keep up with inflation.
Gov't bonds are the safest simply because the govt can either print money , or steal, um I mean tax it's citizens.
Yes dividends do not have to be paid. However BMO for example has been paying dividends longer than Canada has been a country. This does not mean they will continue, but it seems like a safe bet.
I am quite comfortable with my paper losses. So long as my dividend is safe, and continues to grow than I could not care less about the current stock price quoted by Mr. market.
I just dont see the attraction to bonds. You get whatever interest plus you get your principle back. I also get an interest/dividend payment, plus my principal will have grown more than likely (over the long haul) right along with my dividend growth.


investment grade corporate bonds are a completely different species from any type of government bond.

If you don't know anything about corporate bonds, i suggest you go to the bookstore or library and read either editions of Hank Cunningham's book "In Your Best Interest: The Ultimate Guide to the Canadian Bond Market". He offers excellent and objective information, education and strategies for the DIY Canadian investor. He provides sample portfolios, how to build a positive relationship with an investment advisor, even the commission rates of the big Canadian financial institutions (TD and BMO are tops).

I'm not associated with him in anyway, I've just read a lot of investment books and I found that one to be the only objective, unbiased look at investments. Every other author ultimately described investment strategies based on past experiences. Hank's strategy (which is common to all top-quality investment advisors) is customizable to any individual's needs at any point in any economic cycle. The book demonstrates what he talks about.

So if you don't know what a corporate bond is, or how to buy one, now may be the perfect time to learn how and why.

please, read my blog if you want to know more about my feelings on personal investments for the DIY Canadian investor


i agree that dividends are a nice bit of frosting on the cake- but i don't look at equity investments as much more than that. I as well own BMO and am happy to own it at any price.