DIY Finances left the following comment in response to an earlier debate on RRSPs that elicited a lot of comments:
I saw you mention that you hold your dividend paying stocks in your RRSP. Not that there is anything wrong with that, but dividends are tax-advantaged income. By that I mean you pay less tax on it than if it was another form of income such as interest.
By holding those stocks in your RRSP, you have taken away the tax advantage of dividends as all the income in your RRSP will be taxed at your marginal rate when you collapse the RRSP.
Foreign (including U.S.) dividend-paying equities are not eligible for the dividend tax credit, so the RRSP is a good place to put these investments. I have very little exposure to bonds and if I had bonds, a RRSP will be the logical place to hold them.
I would argue that a RRSP is a good place to put Canadian dividend-paying equities for high-income earners. Let’s say that a person earns more than $72,756, which in Ontario would attract a marginal tax of 27.5% on dividend income and 21.70% on capital gains. Of course, if the dividends or capital gains income were within a RRSP, it is tax sheltered.
Let’s assume that our high-income earner plans to retire and start making withdrawals from their RRSP and have no other income. In Ontario, withdrawals of $36,000 will be taxed at an average of roughly 15%. That’s not bad! A RRSP allows taxes to be deferred from a high-earning period to a low-earning period and in the meantime, it has also provided tax-sheltered growth.
That’s exactly my strategy. I hold dividend-paying equities (both foreign and domestic) inside our RRSPs and I keep low- or no-dividend equities in a taxable portfolio. However, note that low-income earners may be better off not saving in a RRSP as the marginal rate on dividends for incomes of up to $34,000 is only 3%.
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13 responses so far ↓
1 Investorial // Mar 19, 2006 at 11:58 pm
Why would you plan to be in the lowest tax bracket? It doesn’t make any sense to say that! I don’t like quoting RK but in this case, why “plan to be poor”?
Plus, saying that you have no other income is untrue, who would turn down the OAS, or any other pension that they may lying around. I’m not saying there’ll be there. But there certainly are other income.
I like the accumulation rationale, the reinvestment of dividends will gather a lot of dividend producing shares fast and without taxation in an RSP. I wish there were some way we can extract the shares out of RSP in-kind into an after-tax account instead of cashing it out. If allowable, perhaps when I convert the RSP into a RIF, rather than taking cash value, I could take out the shares in-kind and put it into a normal account, so that my shares are still giving me dividend. Is that possible?
2 Canadian Capitalist // Mar 20, 2006 at 8:36 am
I am not planning to be poor at all. Let’s say my spouse and I each withdraw $35,000. That’s a very comfortable retirement! Of course, if we get OAS and CPP it is just gravy (I am just not counting on it being there).
Also, I think you can make in-kind withdrawals, but I am not sure.
3 0xcc // Mar 20, 2006 at 8:40 am
If you held those dividend-paying stocks outside your RRSP you could have dividend income of around $32,000 in Ontario and pay 0% tax on that (if the dividend income was your only source of income).
There are other ways to keep the CRA away from your dividend income. Using a loan for investing is one way (you can deduct the interest), contributing just enough to your RSP to offset the tax liability from the dividend income is another way.
Holding things like bonds and non-Canadian stocks makes total sense since income from those investments are not tax advantaged at all. So if you consider that having a good balanced portfolio means holding both bonds and stocks outside of Canada then having a RSP account for the express purpose of deferring tax on income from those sources makes sense. Using the income from the non-RSP part of your portfolio to fund your RSP can also make a lot of sense. However, it really depends on what the individual investor is comfortable with.
4 0xcc // Mar 20, 2006 at 8:43 am
Doh! First sentence of the third paragraph in my post should read:
Holding things like bonds and non-Canadian stocks inside a RSP account makes total sense since income from those investments are not tax advantaged at all.
5 Rick // Mar 20, 2006 at 9:22 am
One thing for me: Dividend stocks PAY. they tend to be winners, and I want growth. Why invest in anything else?
cheers
Rick
6 Canadian Capitalist // Mar 20, 2006 at 10:19 am
Rick: In a taxable account, assuming you want to reinvest your dividends, every time a dividend payment is received it gets a tax haircut. If no dividend were paid and the earnings were reinvested in an excellent business, compounding will work its magic. In a taxable account, I want to invest in superior businesses that pay little or no dividends. In tax sheltered accounts like a RRSP, I prefer healthy dividend-payers.
7 Jason // Mar 20, 2006 at 9:45 pm
ditto, it’s twofold, from a tax perspective and the fact that for my RRSP money, everything has got to do some work and pay me on an ongoing basis, not sit and wait for some speculative payoff
8 Investorial // Mar 20, 2006 at 10:26 pm
$35,000 maybe a comfortable retirement, but not sure what they looks like with inflation 20 years later. The tax bracket should increase in step with inflation I guess, has anybody ever done a correlation.
Limiting myself to withdrawal a certain limit when I retire just doesn’t seem very appealing to me. But that’s myself. I personally believe the advice of you should be in the lowest tax bracket ranks right up there with “buy term and invest the difference”, the problem is, people seldom invest the difference.
Similarly, I believe people are in their low tax brackets not by choosing but by necessity, for people who are planning their financial matter prudently at a young age, it shouldn’t be the “out” that they’re looking for. =) Great debate/perspectives from all so far!
9 Investorial // Mar 20, 2006 at 10:27 pm
I’m very sorry for the atrocious grammer/spelling in that last comment… I’ll slow down next time!
10 James // Mar 21, 2006 at 6:39 am
I’m a big believer in dividends, and drips in particular. There are a large number of quality Canadian companies with steady and increasing dividend payments. That to me is the big benefit of the big dividend paying companies; they have a long established business with a competitive advantage meaning those dividends are quite safe over the long term and they will generally grow faster than the rate of inflation. I choose to keep them outside an RRSP so as to take full advantage of the dividend tax credit. I have a rock solid defined benefit pension at work which I consider my RRSP and thus all my private investments are outside my RRSP so that I accumulate both RRSP and non-RRSP investments. I always worry that Ottawa could change the rules on tax vehicles(RRSP/dividend tax credit etc…) at any time so by having some RRSP and some non-rrsp investments I diversify among investments and invesment vehicles to help minimize risk, in this case political risk.
Investorial…Tax brackets are tied to the CPI(inflation rate) so they will continue to increase as inflation chugs along. And if you do your homework on the investments you chose the dividends will increase faster than CPI and you will have more cash in 20 years than you might expect. For example Loblaws has grown there dividend by an average of 23% per year over the last ten years, Scotia by 15%, CIBC by 14% and there are plenty of others if you just look. Assuming these numbers slow down considerably over the future years, I still expect they will outpace inflation by a wide margin going forward.
11 Humble Investor // Mar 21, 2006 at 8:17 am
An excellent discussion CC.
A couple more random thoughts/responses:
1. James - I agree with you wholeheartedly regarding DRIPs and dividends outside an RRSP. One note though - tax brackets were not always indexed for inflation, and it is possible (though unlikely) the present policy could revert.
2. The Ontario budget is due out on Thursday - any bets if they will change their dividend tax policy to mirror the federal changes of last November?
12 Rick // Mar 21, 2006 at 9:28 am
I dunno if I am misunderstanding, but I am going to repeat my point, with better explaining
I need a large amount of money in my RSP to retire from, in about 30 years. large. L-A-R-G-E. Long term, dividend payers tend to do the best, so that is where my money should sit, regardless of taxable or not taxable. x amount of money is going into my rsp, and once in there, needs to grow a lot to get to my goal. Dividend paying stocks are the best choice.
hope that helps. cheers
13 Kevin Malone // Jul 26, 2007 at 1:07 pm
Boy, this one is confusing. Seems to me just build up a big non-RRSP portofolio of income generating dividend-tax-credit-eligible investments and you can stop worrying about all this RRSP crap (former RRSP addict, fully recovered). The income is your retirement fund, and you don’t have to agonize about when to retire or not retire, take it out not take it out…that’s not how I want to spend my later years!
Kevin
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