Tax Optimization could be the best way to immediately improve your investment income

sea beach vacation couple
Your pic here, thanks to better after tax investment income

No one has ever accused the Canadian tax system of being too generous

(except the 33% of Canadian Tax Filers who don’t pay any tax, according to the Canadian Taxpayers Association, but think that the “wealthy”, meaning us, should pay more).

Dividend income- the best deal in Canada

As the table below shows, taxable income between $25,000 – $46,000 (after pension splitting) incurs a Negative tax rate on dividend income. That’s right – you get back more than 100% of the dividends in Ontario. Up to $75,000 per year, the tax rate is a very reasonable 9%. (It goes sky high above that because of the OAS Clawback and the higher tax bracket introduced in recent budgets). Compare that with the effective tax rate on interest income or withdrawals from a RIF or RSP.

Tax rates in Ontario after clawbacks, 2018

Blog 2 Tax brackets

Now, some will argue that for many investors, those with an income over $85,000, capital gains are a better way to go. But I have discovered that most individual investors, including myself, are truly terrible at timing the sale and purchase of stocks or funds, and prefer to buy and hold and reap the benefit of long term investing.

Preferred shares pay dividends but act like fixed income

In addition, Preferred Shares, which act more like fixed income than stocks, also produce tax advantaged dividends. So one can combine both asset growth through dividend paying stocks and dependable income through preferred shares, and still benefit from the tax system.

Where to hold your dividend investments is highly dependent on your annual taxable income, but here are some suggestions applicable to Ontario residents:
Up to $46,000                       Taxable account
$46,000 – $75,000                TFSA first, then taxable
75,000 – 121,000                 TFSA first, then taxable
121,000 +                              TFSA first, then taxable
If your taxable income is over $75,000, holding dividend payers in a TFSA is a great idea as you get the income totally tax free. And each year that the contribution limit is increased, you can contribute that amount from your taxable account plus the amount that you withdrew the year before. That is a great way to move funds from taxable income to tax free. I really, really like tax free. Do it now before the government changes its mind, which I suspect they would like to.

Exchange Traded Funds (ETFs) are a great low cost way to diversify

What should you invest in to generate these dividends ? There are  Dividend Stock Exchange Traded Funds (ETFs) available that pay a dividend of about 4% and should grow the dividends over time. Check out XDV, CDZ, VDY, PDC, XDIV and ZDV. If you are comfortable with individual stocks, the Canadian banks, insurance companies, pipelines and infrastructure companies pay dividends of between 3.5-6%. Remember – it must be Canadian to benefit from the dividend tax credit and these advantageous tax rates. Many investment advisors refuse to sell ETFs. Why ? Because they don’t receive the high trailer fees that Mutual Funds provide, usually 1% per year or more. The solutions are to find a Fee Based advisor or open an Online Discount Brokerage Account (every bank now has one) and buy your ETFs at $9.95 a trade or less.

There are also diversified Preferred Share ETFs available such as ZPR, CPD, RPF and HPR that currently yield about 4.5%, but may forgo future capital appreciation and dividend growth.

Clearly, it doesn’t pay in any case to hold dividend payers in a RIF as you will pay more tax on withdrawal then you will in a taxable account. Instead, use your RSP/RIF to hold interest earning securities such as GICs and bond funds, as you will pay the same level of tax no matter where you hold them.

Please remember, Investing Incurs Risk. You must do your own due diligence before making any investment decision. This site does not provide personal financial advice, but only seeks to provide readers with options and information that they can use to make their own decisions. See your investment advisor for detailed advice.

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