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Discussion Starter #1
this is a conceptual question, and occurred to me amid discussions of tax benefits associated with (for instance) holding dividend paying stocks in a non-reg account.

i understand that in a non-reg account, income derived from dividend stocks is taxed more favourably than working income. prior to the TFSA, it would be beneficial to hold the dividend stocks in a non-reg account to take advantage of the lower tax rate, as opposed to keeping it in an RRSP, in which case you are not taxed more favourably, you are simply taxed at a later date (i.e. retirement).

but with the introduction of the TFSA, since you contribute with after-tax dollars, and you don't pay any tax on dividend income held in the TFSA, it is preferable to put dividend stocks in the TFSA before a non-reg account.

so while it was previously better to put dividend stocks in a non-reg account, than in an RRSP. now, it is better to put dividend stocks in a TFSA than a non-reg account. moreover, you would only really put dividend stocks into a non-reg account if you've maxed out the TFSA.

am i understanding this correctly?

thanks!
 

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Dividend income from eligible Canadian Corporations is taxed favourably (it's grossed up 45% then a 19% federal tax credit is aplied to the grossed up amount for 2009, provincial credits vary). Therefore, dividend income is taxed much more favourably than employment or interest income, which is added to your taxable income.

Which investment vehicle you choose - RRSP, TFSA, non-registered account - depends on your personal circumstances and investment objectives. If your total investments are relatively small, and your marginal tax rate is low then a TFSA may be your best option no matter what the investment is (capital gains, dividends, or interest).

If your investments are more than your TFSA can hold then dividends are definitely better than interest income in a non-registered account. For example, if your income is less than $40,970 in Alberta (for 2009) then your tax rate on the dividends is negative 5.75%! That is, the tax credit saves you more tax than the grossed up amount costs you. Please note that the grossed up amount, and the amount of the tax credit, is scheduled to decrease in future years.

What are your investment objectives? If you want growth then you may want to use dividends or capital gains in a TFSA or RRSP. Which registered vehicle you use depends on your present MTR vs. your estimated marginal effective tax rate (MTR + clawbacks of social benefits) in retirement. MoneyGal gave a great link to a CD Howe report that showed savings in a TFSA gave retirees more money in pocket than a RRSP if the MTR were the same pre and post retirement. the kicker is that tax rates (when you include clawback of benefits) is higher post retirement than pre retirement at modest to medium income levels.

I wish I could give you a simple answer, but you're going to have to sit down with a calculator to sort out the best option for you. For the 2009 tax year in AB, say you have $1,000 to invest in either a savings account paying 1% or dividend-paying stock(s) yielding 5% (in a non-registered account). If your income is less than $40, 970 in AB, the savings account would pay you a grand total of $10, which is added directly to your taxable income and taxed at 32% (combined federal and provincial rates). So your savings account, after tax, nets you $6.80. If you invested in a security yielding 5%, the dividend is $50, which is taxed at -5.75%. So the dividend leaves you with an extra $52.88. Again, gross up rates are scheduled to change in the future.

If you plan to use the registered account as an emergency fund, then the TFSA account easily beats an RRSP because withdrawing from an RRSP causes you to lose contribution room while withdrawing from a TFSA does not.
 

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Discussion Starter #4
wow! thank you for your thorough response! it's certainly added to my understanding of canadian taxes.

my current situation lies pretty much between putting dividend stocks into either TFSA or non-reg account. I've already maxed my RRSP contribution for this year. In 2009, i contributed less than 5000 to my TFSA, so there is contribution room remaining. At this point, since I want to buy dividend stocks, my understanding is that it would make most sense to put these dividend stocks into my TFSA, as opposed to a non-reg account. My rationale for this is that in a TFSA, i would be paying zero tax on earnings, whereas in a non-reg account, i would be paying a relatively lower (compared with employment/interest income) tax rate, but non-zero. Based on this rationale, I would believe that any dividend stocks should be placed in my TFSA first (up to the max limit) before placing any of these stocks in a non-registered account, correct?

i understand that this would come at the opportunity cost of using the remaining TFSA contribution room to buy securities that could potentially provide me with a return that is greater than the dividend yield.

am i getting this right?

btw, main goal is for growth. horizon is about 30+ years.
 

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If the amount you can invest is less than your TFSA contribution room, then it's a no brainer to contribute to your TFSA before a non-registered account. We discussed dividends only. As mentioned it is possible to get a negative tax rate on dividends if you're in a low tax bracket, but the tax man has seen this and is moving to reduce the dividend tax credit for future years.

I didn't mention capital gains. If you're aiming for growth, then at least some of your growth will be from capital gains. Again, using AB as an example, at less than $40,970 the combined federal/provincial tax rate is 32%. So if you have a $1,000 capital gain, 50% of that is added to your taxable income. Your tax bill would be 32% X $500=$160 (or 16% of your capital gain).Not bad. In a TFSA your tax bill from the capital gain would be...0. There's at least one big disadvantage with the TFSA: you can't deduct capital losses from capital gains.

If your investment horizon is 30 years then you may want to aim for dividends/ capital gains in the TFSA while sheltering interest income within your RRSP. Congratulations on getting such an early start! Another downside to dividends is that at small amounts the dividend is hard to reinvest. For example, $5,000 yielding 3.5% is only $175 per year. If you have a self-directed TFSA (I would suggest this if you want to buy dividend-paying stocks yourself), then you have to spend a commission to re-invest the $175. One way around this is to use a DRIP (dividend re-investment program). Many stocks/REITs (all the big 5 banks) have this. The DRIP will automatically re-invest the dividend in the stock for you - no commissions. Canadian Moneysaver has a lot of articles about DRIPs and a list of securities that offer it. Another downside of the DRIP in a TFSA is that $5,000 doesn't allow for much diversification. If you buy an ETF made up of dividend paying stocks (e.g. XDV or CPZ) you get diversification but not a DRIP. I may be mistaken, but I believe that TD, at one point, re-invested dividends from some ETFs for their clients (most ETFs don't have a DRIP). Good luck!
 

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Discussion Starter #6
Thank you very much! those are all good points to consider.

I'll look into more DRIPs on Canadian Moneysaver as you suggested. I already have some TD e-series index funds under DRIPs, but yes, I haven't come by many DRIP ETFS except for some offered by Claymore. I had wanted to keep as few accounts as possible, and i didn't want to have to open an account with Claymore because i already have registered accounts with questrade and TD.
 

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If your income is low enough and depending on whether you live in a province with a negative MTR on dividends you would be better to hold them in a nonreg account. If at some point the dividend rate goes up to eliminate the negative tax rates you could move a portion to your TFSA until your limit is reached.
 

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Obviously yes it would be better to have 5000 of funds in a non taxable account, vs a taxable account, regardless of the tax breaks offered in dividend return.

I am completely for holding dividend paying stocks, but you mentioned your main objective overall was growth, I am not so sure if dividend stocks would be best for that.

If you are interested in accumulating more shares, then the DRIPs are the way to go. Especially so as to incur less transaction fees.
 
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