Dividend Tax Rate

After completing my income tax I used QuickTax to do a few "What If?" calculations.

I currently have no direct income from dividends but I expect to get into that as time goes on. My current marginal tax rate is 21 percent. This means that if I was to earn money from employment or have additional interest income, I would pay $21 tax on the first $100.

I knew that dividend income had a better tax rate. Both the federal and provincial levels of government in Canada want investors to buy shares in companies that pay dividends so they give "tax credits" for any dividend income. A tax credit is code for a lower tax rate. Companies that pay dividends include the major banks such as TD Bank, Bank of Montreal, Royal Bank and so on.

I added several amounts of additional dividend income on Schedule 4, line 2, to see how much additional tax I would pay. The results are interesting.

$100, $4 additional tax , 4 % tax rate
$500, $28 additional tax, 6 % tax rate
$1000, $58 additional tax, 6 % tax rate

The 2006 tax rate for the additional dividend income is only 4-6 percent. This is quite low relative to my 21 % marginal tax rate for other types of additional income.

Sweet!

ps: I will be away for about a week so I will not be posting.

Update, May 7th

I went back and tried adding "eligible dividend" income in line 6 of schedule 4. In this case, believe it or not, I would actually pay less tax than I do without the additional income. The combined federal and provincial tax credits exceed my marginal tax rate. For example, if I had $1,000 in additional "eligible dividend" income I would pay $97 less income tax!

Stocks That Pay Dividends

The Royal Bank has been doing very well in recent years. In addition to capital appreciation, it is currently paying a 3.1 % dividend rate. I think one needs to consider both the potential for dividends and the stock price appreciation. The chart says it all.

I have also recently discovered that one can purchase mutual funds that include only stocks that pay dividends.

One fund I took a quick look at today was the TD Dividend Growth - I. It pays a 3.4% dividend and contains 63 stocks. The majority of the fund seems to be in the Canadian Banking sector. The top holdings include; the Royal Bank, the Toronto Dominion Bank, CIBC Bank, and the Bank of Nova Scotia. It is a no load fund, RRSP eligible, has minimum purchase amounts of $100 initial and $100 additional. The MER seems reasonable at 1.97%.

If I decided to move toward owning dividend paying stocks I think I would prefer the mutual fund approach rather than buying individual stocks. I like the lower risk with diversification and the lower initial investment amounts. For example, to buy Royal Bank shares at $58 per share one would need a lot more than $100 to get started.