Top dividend stocks offer many benefits for Canadian investors—including the dividend tax credit
Here are five tips for dividend investing, including information on dividend tax credit plus characteristics to look for in the best dividend-paying investments.
Insist on the best
The best blue chips are your surest promise of powerful, growing returns for years. But some so-called “blue chips” are coasting on their past reputations. Our free report shows how and where to find the best of Canada’s blue chips. And identifies 7 top blue chip recommendations.
Tip 1: Dividend tax credits can increase returns for Canadian investors
Canadian taxpayers who hold Canadian dividend stocks get a special bonus. Their dividends can be eligible for the dividend tax credit in Canada. This dividend tax credit—which is available on dividends paid on Canadian stocks held outside of an RRSP, RRIF or TFSA—will cut your effective tax rate.
This means that dividend income will be taxed at a lower rate than the same amount of interest income. Investors in the highest tax bracket pay tax of around 29% on dividends, compared to 50% on interest income. At the same time, investors in the highest tax bracket pay tax on capital gains at a rate of about 25%.
Tip 2: Dividends can produce as much as a third of your total return over long periods
Dividend stocks rarely get the respect they deserve, especially from beginning investors. That’s because a yearly 2% or 3% or 5% dividend barely seems worth mentioning alongside possible yearly capital gains of 10%, 20% or 30% or more. But dividends are far more reliable that capital gains. A stock that pays a $1 dividend this year will probably do the same next year. (It may even raise the rate to $1.02).
And as we mentioned, dividends from Canadian companies come with a tax credit. This cuts your tax rate. (Note: the credit is non-refundable and can only offset income taxes owed. But you can transfer it to your spouse under certain conditions.)
Tip 3: Dividend Reinvestment Plans (DRIPs) can offer benefits to investors
Some companies provide dividend reinvestment plans, or DRIPs, that let shareholders receive additional shares in lieu of cash dividends. DRIPs don’t require the participation of brokers, so shareholders save on commissions.
DRIPs also eliminate the nuisance effect of receiving small cash dividend payments. Second, some DRIPs let you reinvest your dividends in additional shares at a 5% discount to current prices. Third, many DRIPs also allow optional commission-free share purchases on a monthly or quarterly basis.
Tip 4: Unusually high dividend yields can be a danger sign
Investors should avoid judging a company based solely on its dividend yield (the percentage you get when you divide a company’s current yearly payment by its share price). That’s because a high yield can sometimes be a danger sign rather than a bargain. For example, a dividend paying stock’s yield could be high simply because its share price has dropped sharply (because you use a company’s share price to calculate yield) in anticipation of a dividend cut.
That’s why we recommend that you look beyond dividend yield when making investment decisions, and look for companies that also have established a sound business and have a history of building revenue and cash flow.
Tip 5: Dividend tax credits do not apply to income in an RRSP
Registered Retirement Savings Plans, or RRSPs, are the best-known and most widely used tax shelters in Canada.
RRSP contributions are tax deductible, and taxes are deferred on growth in the value of investments you hold in an RRSP. You only pay taxes on RRSP withdrawals. However, RRSP tax advantages come at a cost. RRSP withdrawals are taxed as ordinary income. In an RRSP, you don’t get any benefit from the lower rate of tax on capital gains (half the rate you pay on ordinary income), and the dividend tax credit doesn’t apply to dividend income you get in an RRSP.
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