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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

ProvinceMaximum Income
NL$40,726
NS$29,590
PE$40,726
NB$40,726
QUtaxed 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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FT About the author: FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.

{ 34 comments… add one }
  • canadian dollars February 5, 2007, 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.

  • Investor February 13, 2007, 1:07 am

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

  • Konstantin September 18, 2007, 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.

  • FrugalTrader September 18, 2007, 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.

  • Cannon_fodder September 18, 2007, 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.

  • Konstantin September 18, 2007, 4:47 pm

    FT /C_F,

    Thank you guys!

  • FinancialJungle.com January 9, 2008, 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.

  • newbie January 15, 2008, 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).

  • FrugalTrader January 15, 2008, 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).

  • newbie January 16, 2008, 12:59 am

    so that makes it better outside of rsps?

  • newbie January 16, 2008, 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 January 16, 2008, 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.

  • newbie January 17, 2008, 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.

  • YJ January 11, 2009, 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,

  • Big Cajun Man August 21, 2009, 9:51 am

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

  • FT FrugalTrader August 21, 2009, 10:07 am

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

  • KK September 2, 2010, 8:29 am

    Hi FT,

    Would you please update the table with the 2010 numbers?

    Thanks!

  • FT FrugalTrader September 2, 2010, 8:37 pm

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

  • Showtime November 27, 2010, 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.

    • FT FrugalTrader November 27, 2010, 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.

  • Showtime November 27, 2010, 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.

  • FT FrugalTrader November 27, 2010, 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://www.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.

  • Marcus August 19, 2014, 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

    • FT FrugalTrader August 19, 2014, 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.

  • Andrew September 24, 2017, 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?

  • New Reader September 24, 2017, 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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