Why you’re getting a tax break on dividend income

In some provinces, you may not have to pay any taxes at all

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From the February/March 2016 issue of the magazine.

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Our made-in-Canada tax advantage

You might be aware that Canadian dividends have a tax advantage over regular income when they’re held in non-registered accounts. But the tax calculations are complicated, so you may not realize how it impacts you. Here’s the combined federal and provincial marginal tax rates you actually pay on Canadian dividends using B.C. as an example, as provided by taxtips.ca, and estimated based on Liberal tax promises.2016 Marginal tax rates

Note that Canadian dividends will get you a nice tax break at all income levels, but the benefit is especially large if you’re in a lower tax bracket.

Amazingly, if you’re in a low enough tax bracket in some provinces (including B.C.), you not only pay no taxes on dividend income at all, but the dividends cause a further small reduction in the rest of your taxes. This is a rare and delightful example of a “negative marginal tax rate”.

The actual calculations are pretty complex and go through a three-step process. First, dividends received are grossed up and included in taxable income. Second, a percentage tax rate is applied and, third, you receive a dividend tax credit which knocks your net taxes back down. The positive impact of the dividend tax credit is greater than the negative impact of the gross up.

A further complication to consider is that while dividend income is taxed favourably, it hurts you when it comes to income-tested government benefits such as the Old Age Security clawback. That’s because the income test incorporates grossed-up income—step one of the three-part process—not the dividends you actually receive.

Related: How to buy dividend stocks

2 comments on “Why you’re getting a tax break on dividend income

  1. The first $11,373 of income is income tax free today. This will likely be double, $22,746 in 30 years. TFSA income or returns in there are tax free as well. So it is possible to have in retirement $500,000 in a TFSA getting $20,000 in bond interest.

    The age amount currently is $6,500 which will be $13,000 in 30 years starts cut off today at about $35,000 of income which will be $70,000 in 30 years. This that another $500,000 in RRSP’s in retirement would bring in another $20,000 interest.

    Add another $36,000 in C.P.P., OAS pension in 30 years and only $6,000 would be taxable in an amount of $1,500. On $76,000 in income in retirement, a retiree would pay an overall effective income tax rate of 1.9736%. This is less than 2%.

    Even if this retiree had another $20,000 in interest income from GIC’s, bonds etc. this would be another $6,000 in extra income tax and partial clawback of age amount. This would still mean only a modest 7.8125% overall effective income tax rate.

    Why would someone need dividends? keeping 92% to 98% of all income in retirement is almost pretty much keeping most of it. If I got a 92% or 98% grade on a test in school. This is excellent as this is too.


    • “Why would someone need dividends?”

      Because with a little advance planning and awareness of the tax benefits of dividends, a single person or couple with a very modest retirement income (and $76K/year WILL be a very modest retirement income in 30 years) could keep 100% of retirement income rather than 92%.

      For a retired person or couple with a modest income, an extra $6K a year after tax can make a significant difference in their quality of life.


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