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How Are Dividends Taxed? How Can They Lower Taxes In Retirement?
Dividends from Canadian corporations receive some special tax treatment that can make them an attractive investment in non-registered accounts. This special treatment means that they can help lower your average tax rate, especially in retirement.
But this special tax treatment makes it a bit confusing to understand how dividends are taxed. To calculate tax on Canadian dividends there are things like “gross ups” and dividend tax credits to consider.
Despite the extra confusion caused by this special tax treatment it can be very attractive to invest in Canadian companies. For most people there is a significant tax advantage when receiving Canadian dividends. For example, in Ontario, a retiree in the lowest tax bracket will experience a negative tax rate on eligible dividends!
The way these eligible dividends are taxed can help offset other income from CPP, OAS, pensions and RRSP withdrawals. With a bit of tax planning this advantage could add thousands in after-tax income for a retiree.
In this post we’ll look at how dividends are taxed, the difference between eligible and non-eligible dividends, and we’ll look at an example of how eligible dividends can help lower taxes in retirement (all the way to zero!).
Lastly, we’ll also look at how the dividend gross up can also trigger OAS clawbacks for high income retirees. A surprising negative of the way dividends are taxed (although it’s still an attractive form of income).
What’s Worse In Retirement? An Investment Decrease Or A Spending Increase?
A large decrease in portfolio value is a common concern when entering retirement. After all, seeing a large chunk of your retirement portfolio evaporate over just a few months can be quite disconcerting.
But… a large spending increase should be much more concerning in retirement.
If you had to guess, between a 20% drop in portfolio value and a 20% increase in spending, what is worse for a retirement plan?
It feels like a large stock market correction of 20%+ is the worst thing that can happen in retirement. After all, for an average retirement portfolio, a 10-20% drop could equate to a portfolio decline of $50,000 to $200,000+. That’s a large amount of money!
But a permanent increase in retirement spending should be much, much more concerning.
An increase in retirement spending of 10-20% is significantly worse than a 10-20% portfolio decline. Let’s see why…
Safe Vs Max Retirement Spending
If you’re thinking about retirement, then one big question you probably have is how much you can spend in retirement without running out of money in the future.
You probably want to know how much retirement spending your investment portfolio, CPP, OAS and other retirement income can safely support.
In this blog post we’re going to take a closer look at two important levels of retirement spending, your “safe” level of retirement spending and your “max” level of retirement spending.
These are two very important spending levels that every retirement plan should highlight. Your “safe” and “max” level retirement spending represent both lower and upper guardrails for your retirement plan.