November 2021 Dividend Income Update
Just like not all stocks are created equal, not all income is taxed the same. Welcome to this latest update: my November 2021 dividend income update.
Hybrid investing 101
As a passionate investor and subscriber to this site, you already know that I have a two-pronged hybrid approach to investing:
- Approach #1 – we own a number of Canadian dividend paying stocks for income and growth. We own nearly 30 different Canadian stocks within our non-registered account and across our Tax Free Savings Accounts (TFSAs). We own these stocks because we believe buying and holding our DIY bundle of Canadian dividend-paying stocks will, over time, provide some steady monthly income for future wants and needs in retirement.
- Approach #2 – we’re owning more units of low-cost U.S. Exchange Traded Funds (ETFs) inside our RRSPs over time.While dividend paying stocks are great, we believe this is smart because we’re investing abroad beyond Canada’s borders. In doing so, we’ll add growth and diversification to our portfolio. While we still own some Canadian stocks and some U.S. stocks inside our RRSPs, (names like Procter & Gamble, BlackRock, and Johnson & Johnson to name a few) we’re buying more (and holding more) U.S. ETF units every quarter going-forward.
So, with those approaches in mind – you should know we strive to max out contributions to our registered accounts (i.e., x2 RRSPs + x2 TFSAs) before making investments inside our taxable investment account.
Dividend income taxation
When I was just starting out my dividend income investing journey, I found the rules around dividend taxation very messy and confusing to say the least. Certainly, this Grumpy Accountant is correct: our tax system is a mess.
Yet, dividends can be an efficient form of taxation.
- In Ontario (where I live), a person can earn up to $35,000 in non-eligible dividends, or $50,000 in eligible dividends and pay no tax (other than health premiums) as long as they have no other income.
- A shareholder like myself doesn’t have to do anything to receive dividend income other than invest in shares.
- If a person is entitled to a spousal tax credit, dividend income can sometimes be transferred between spouses on their tax returns to minimize tax.
But, dividends aren’t everything:
- For seniors receiving Old Age Security (OAS) benefits, the dividend gross-up system can cause the loss of benefits if the dividend gross-up causes a senior to have income above the clawback threshold. (Really, OAS clawbacks are a high income problem to have!!)
- Dividend income is taxed, certainly when combined with other income sources above certain levels in a taxable account, so when an investor has significant dividend income, capital gains could be an efficient form of taxation.
That brings me to this: income types are treated differently by the Canada Revenue Agency (CRA) which makes our tax system challenging to navigate. For example, like employment income, interest income typically earned on such investments as Guaranteed Investment Certificates (GICs) or savings accounts is taxed at an individual’s highest marginal tax rate, making it the least efficient form of investment income. This means, any GICs and/or bonds that deliver interest bearing income should usually be owned in registered accounts (such as TFSAs, RRSPs, RRIFs, etc.). Again, not always.
By contrast, dividends paid on stocks issued by eligible Canadian corporations receive more favourable tax treatment, since this type of income benefits from the federal dividend tax credit. Therefore, far more than interest income, dividend income is more tax-efficient which ultimately means that investors in dividend-paying investments keep more of what they earn after taxes.
Capital gains on the other hand materialize when you sell your investment for a higher price than what you paid for it. This difference is recognized as taxable income. Capital gains also receive relatively favourable tax treatment, since only half of the capital gain is subject to taxation.
Here is a quick summary of in table format what I shared above, distributions you may receive and how they are taxed:
|Type of distribution||Description||Tax Treatment|
|Interest||Interest is earned on investments such as GICs and bonds.||Fully taxable at the same marginal tax rate as ordinary income, like employment income.|
|Canadian dividends||Income when you invest in shares of Canadian public corporations that pay dividends.||Preferential tax treatment for individuals through dividend tax credits as either eligible or non-eligible dividends.|
|Capital gains||Realized when an investment is sold for more than the adjusted cost based (ACB) of the investment.||Preferential tax treatment as only 50% of a capital gain is taxable.|
There are also foreign dividends and return of capital (ROC) as potential tax liabilities, but I’ll leave that post for another day.
Dividend income versus capital gains
In recent weeks, I’ve seen (and been part of) a few discussions on the dividend investing subject so I’d like to clarify some points from my perspective as a dividend investor, once again, for those detractors of my investing approach:
- Total returns matter. That means, whether my income is derived from a mix of capital gains, dividends or interest, it is my hope to get the best possible return to realize my investing goals.
- Income matters to me. That means, while I strive to achieve strong total returns, as an investor I can’t help but feel and invest in a way that gives me comfort: dividend investing delivers tangible, usable, real income from my portfolio. I will be using the income generated from my portfolio to help fund semi-retirement expenses (ideally in a few years).
- Optimal tax efficiency is great but not at the expense of #1 or #2 above. That means, achieving tax efficiency while very important should never be the first consideration in any investment plan. Your mileage may vary – so the types of investments you or I will own, will differ, and that’s OK! Personal finance and investing has always been personal. That means the tax efficiency of any overall portfolio should not veto your personal financial goals.
So, that brings me back to my income journey and these updates that share a portion of my income journey.
By sticking to a long-term plan I believe in, by minimizing trading fees, by taking some financial advisor out of my money management equation, I should be wealthier for it.
I’m more of the mindset that many good/great decisions are just fine rather than obsessing over any perfect rational decision. Investing, and living your life for that matter, is way more good psychology over math.
November 2021 Dividend Income Update
So while many financial experts or advisors might claim “dividends do not matter”, they do continue to matter to me for many reasons. For one, they are part of desired total returns. Two, the income I receive (i.e., the portion of the corporation’s after-tax earnings to its shareholders) is tangible money I can eventually spend. Three, because they are optional to distribute, to shareholders, I can reinvest my dividends for more compounding power or spend them as I please. And I will spend those dividends eventually.
This time last year, yes, just 12 months ago almost to the day I wrote:
“Even with a few dividend cuts in my portfolio that I’ve written about this year, our taxable and non-registered portfolio is still on pace to earn $20,800 this calendar year – with one month of compounding and time in the market to go.”
12 months later, that income stream has jumped to $24,308. I’ve long since surpassed any 2021 target.
The reasons for this jump are largely due to staying investing, throughout the pandemic, and sitting on my hands watching the companies I own increase their dividends and reward me as a shareholder in the process. At the end of the day, my investing process is helping my wife and I realize our financial independence goals even though our path may not be perfectly rational to some. I believe if you continue to make many good financial decisions over time, for the most part in life, that’s enough.
I look forward to sharing my final year-end update with you in a few weeks including updating the chart below for the big 2021 reveal. Thanks for reading and sharing.