Ah retirement. Or, as my 85 year-old grandfather who still works calls it, “stop being a quitter, pussy.”
(For the record, Gramps works about an hour a week, if that. And most of that time is spent yelling.)
Many people who read this here vomit-encrusted blog imagine a retirement fully funded by dividends. This is why most dividend-growth investors become dividend-growth investors. All they need to do is earn enough to survive during retirement and they’re confident the portfolio will churn out enough raises that inflation won’t be a worry.
People without as much capital will use a combination of CPP, OAS, and various dividends to make ends meet. Or they might get a pension. Remember, it’s going to be easy to get by on a reduced income once you retire.
And so on. This is pretty easy stuff.
It turns out there’s a different reason why you might want to rely on dividends when you retire. Because you won’t pay much tax at all. In fact, if you make under $50,000 per year and live in the right province, you’ll pay 0% income tax in retirement.
Pay 0% income tax
Let’s talk a little bit about the treatment of dividends come tax time. I’ll sexy this up as much as possible, but be prepared. It’s gonna get boring.
First, know the difference between eligible dividends versus non-eligible dividends. The former you get from a publicly-traded Canadian corporation. The latter you’d pay yourself out of your own company.
Say you get $10,000 per year in eligible dividends. When it comes time to pay tax, the government will gross up those dividends to $13,800 and you’d get a dividend tax credit of 20.73%.
So if you’re in the 33% tax bracket, you’d end up paying tax of about 12% of $13,800, or about $1,656. If you received $10,000 in interest payments, you’d be looking at a total tax bill of $3,300.
You can see immediately why people like dividends so much.
Knowing that, let’s dive a little into Canadian tax brackets. All we’ll need to concern ourselves with is the first one, which covers the first $45,916 of earned income. The federal tax rate on that is 15%, and then you’ll have a provincial rate on top of that.
And then there’s the personal exemption, which runs around $11,000 per year.
Let’s assume a simple scenario. A retiree gets $7,000 per year in CPP, $7,000 in Old Age Security, and $25,000 in dividends from your basket of stocks. You live in Alberta because that’s where all the cool kids live.
How much tax will you be paying? The answer is $490. On $39,000 in income. That’s because all the retiree is really paying tax on is the difference between the personal exemption ($11,000) and the amount earned by CPP/OAS ($14,000). Tax on $3,000 worth of income at 15% puts us almost at $490.
Let’s do one better. How about if our imaginary person makes $39,000 per year in just dividends? How much tax would they pay?
The answer is zero — at least in Alberta.
Assuming you have no other income, you can earn about $55,000 in dividends in Alberta and still pay 0% income tax. Depending on the province, taxes will kick in sooner. It depends on each place’s different provincial taxes.
One thing is for sure. It’s way better to get dividend income rather than working. No matter what province you live in.
I played around with a tax calculator and came up with this table. It’s based on $50,000 per year in income from a job or from dividends in each province.
|Province||Tax working a job||Tax on dividends|
Thanks to TaxTips.ca for the tax help. Any errors are mine, not theirs.
Anyway, it’s not even close. There are huge tax advantages to holding a basket of dividend-paying stocks come retirement. You can make a decent amount of money before the government starts taking their share, too.
Should this affect your investing today?
The interesting thing isn’t that this exists. The question is how should you invest?
I can see the logic in wanting to have a nice dividend portfolio come retirement time to take advantage of this. But should it dictate your investment thinking 20 or 30 years before retirement?
Some people say yes. After all, dividend-growth stocks do tend to outperform the market over time.
But there are other approaches that outperform over time, too. Buying small-cap value stocks has worked. So has buying net-net stocks.
I’ll admit that as I get busier writing I’m less inclined to research individual stocks. I like the idea of a buy and hold portfolio without much turnover. The market is also pretty expensive, so looking for cheap stocks bums me out a little.
The bottom line? I can see the logic in building up a dividend portfolio today, but you don’t have to do it. The whole point should be to accumulate the biggest nest egg.
Alright kids, that’s enough. It turns out that if you have a portfolio filled with dividend payers and no other income, you too can pay 0% income tax. That alone is enough for me to encourage y’all focus on dividends come retirement time. What you do in the meantime is up to you.