|Photo by Michelle Spollen on Unsplash|
Before we get started, I wanted to point out that the research I did for this article was extensive and time-consuming. They are a lot of articles written about the dividend tax credit and they cover a lot of the technical aspects, but none of them simplified anything. One of the annoying side-effects of limited FIRE content is the complex and scattered valuable information. If there is one thing I love about the FIRE movement, it has embraced simplicity as one of its core values and I hope to consolidate all of that data into one easy-to-read blog.
The DTC is a non-refundable federal tax credit aimed at reducing 'double taxation'. When corporations pay a dividend to your taxable account, a taxable event occurs and you must report each dividend to the CRA every March. Since the corporations have already paid the taxes on this money, its taxed again when you receive it.
Assuming our government feels bad about this, they allow Canadians to apply for the DTC and they'll waive the taxes depending on your dollar amount gained, your income from other sources and the province you live in. It gets more complex than that but its not relevant to the simplicity of FIRE I mentioned before.
Using the hideous but incredibly informative taxtips.ca calculator or the sleek simpletax.ca calculator, I've run a few scenarios to simulate Ryan-of-the-Future. Let's see how the DTC pans out. Spoiler alert: If you're from BC, get ready to have to your socks blown right off.
Taxable Income: $55,000
Eligible Dividend Income: $20,000
Capital Gains: $0
Other income: $0
Total Taxes Paid (BC): $12,428 (16.57%) [MTR: 31%]
Total Taxes Paid (ON): $14,237 (18.98%) [MTR: 31.48%]
Total Taxes Paid (QC): $18,868 (25.16%) [MTR: 37.12%]
In this scenario, I'm still working for the majority of my income but my marginal tax rate (MTR) is much higher than the taxes I've actually paid in the respective provinces. That's the DTC putting in some work! Keep in mind, to earn $20k of dividend income, you'll need a portfolio of $533k yielding 3.75% (VDY yields 3.95% less a 0.22% MER) Let's try another scenario.
Taxable Income: $90,000
Eligible Dividend Income: $30,000
Capital Gains: $0
Other Income: $0
Total Taxes Paid (BC): $24,022 (20.02%) [MTR: 40.7%]
Total Taxes Paid (ON): $30,835 (25.7%) [MTR: 43.41%]
Total Taxes Paid (QC): $37,588 (31.32%) [MTR: 47.46%]
Again, I'm working now for $90k but because the DTC has been at the gym lifting weights, its doing a lot of hard work. Again, using a 3.75% dividend yield my taxable portfolio would have to be at $800k. I think at this point, I'm done with my full-time job and I want to take a year off.
Taxable Income: $0
Eligible Dividend Income: $50,000
Capital Gains: $0
Other Income: $0
Total Taxes Paid (BC): $0 (0%) [MTR: 28.2%]
Total Taxes Paid (ON): $600 (1.2%) [MTR: 29.65%]
Total Taxes Paid (QC): $1,192 (2.38%) [MTR: 37.12%]
!?!!?!?!?!??!?¿???!!!!!!! I am currently looking at real estate in BC for that sweet geographic arbitrage (just looked, no thanks). At this point the DTC is Arnold Schwarzenegger, just handsome AF. This is the true version of passive income for the regular Canadian. No business, no side hustles, no house hacking. Those things are great but they aren't passive. Straight up stock investing certainly is. You'd need a portfolio of $1.3 million yielding 3.75% to achieve this, a tall order.
I think at this point you'd have to wonder how much money you really need to FIRE. Assuming your RRSP, TFSA and any employer sponsored plans are jam-packed full of money, the taxable account doesn't need to bring in as much dividend income as shown in Scenario #3. That was just for the thrill of it all.
BTW - if you reside in Alberta, Saskatchewan, New Brunswick or any territory, you'll be pleased to know that BC's numbers in Scenario #3 apply to you as well! If you live in Newfoundland and Labrador, I have some bad news... your government hates you. The other provinces are all pretty low. Seriously, give the calculator a whirl and see what comes up. It's one of the few ways to plan your taxes without dying of boredom.
The Risks Involved
To finish off this article, I'd like to go over some of the risks posed by using a FIRE strategy centered around the DTC.
- Canadian-bias risk: The above numbers reflect the dividends only from public Canadian corporations that pay eligible dividends. This means a LOT of your portfolio will be in Canadian stocks. Even if your TFSA and RRSP are fully stocked and dedicated to foreign equities or bonds, you'll likely still have the majority of your entire portfolio on the Canadian TSX just to use the DTC. It's not as diversified and therefore the risk is higher.
- Marginal Tax Rate risk: You'll notice I left capital gains and other income at $0 for all three scenarios. This is because the higher your dividend income, the higher your MTR. In the above scenarios this didn't much matter but if you start earning other forms of income such as RRSP withdrawals, pension income and capital gains, all of these will be taxed depending on your MTR.
- Pretty Pony risk: Remember, a Pretty Pony likes to stay put regardless of the changing circumstances. While I appreciate the DIY nature of FIRE and claiming that sweet DTC all by yourself, I think you're setting yourself up for complex tax burdens in the future when RRSP's, LIRA's, CPP/OAS begin paying out. Do yourself a favour and begin planning your taxes with a professional sooner rather than later. It's boring and tedious and they'll charge you a bunch of money but they'll have invaluable advice. I don't want to be no Pretty Pony, so I plan to do this as well. I think my tax-planning meeting will occur once my spouse and I begin pass $100k in our taxable accounts or we believe we can FIRE, whichever comes first.
- Chasing Dividends risk: I asked about the DTC on the ChooseFI Canada Facebook Group and received a good chunk of advice. It boiled down to this: "Don't chase dividends for the sake of a tax credit - get the best total returns with taxes already planned." So basically, make the most amount of money you possible can and can include the DTC but it doesn't have to. Go with the math.
- For example, an Ontario resident claiming $25k in capital gains and $15k in eligible dividends will only pay $361 of taxes (0.9%), assuming $0 in any other income. So get the best return, always. Then use the DTC.
Here are the resources I've collected that should help you:
- TurboTax: How the DTC Works:
- Financial Post: Dividend Tax Credit
- Canadian Couch Potato: Making Taxable Accounts Easier
- Millennial Revolution: Making Investments Tax Free
- taxtips.ca: AMT