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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.

Province Maximum Income
NL $29500
NS $29500
PE $37100
NB $37100
QU $29900
ON $35900
MB $37100
SK $37100
AB $37100
BC $68700

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 $68700 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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19 Comments, Comment or Ping

  1. 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. 2. Investor

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

  3. 7. Konstantin

    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.

  4. 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.

  5. 9. Cannon_fodder

    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.

  6. 10. Konstantin

    FT /C_F,

    Thank you guys!

  7. 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.

  8. 14. newbie

    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).

  9. 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).

  10. 16. newbie

    so that makes it better outside of rsps?

  11. 17. newbie

    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?

  12. 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.

  13. 19. newbie

    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.

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