Jim Grant’s financial column

More on the continuing dividend conundrum in today's business column of the Parksville Qualicum Beach News

By JIM GRANT

NEWS columnist

 

For income investors there are few strategies that are proven to be as effective as investing in successful companies that pay their profits to shareholders in the form of dividends. Unlike interest earned on GICs and bonds, dividends tend to rise over time, keeping pace with inflation. In addition, dividend-paying stocks themselves will often increase in value over time — even after paying out dividends.

There can be a downside to dividends however, usually involving taxation. As previously discussed, dividends can be the most tax-efficient way of receiving investment income — often resulting in negative taxation. But for some it can be the opposite.

The problem has to do with how dividends are taxed. Unlike interest income which is included dollar for dollar in taxable income, dividends are grossed up by 38 per cent when determining a taxpayer’s taxable income.

Ultimately this is offset by the dividend tax credit, but often not before the damage is already done. Retirees typically are impacted the most, as eligibility for programs such as the GIS or Old Age Security does not benefit at all from tax credits, and is subject to potential claw-back on the basis of the grossed-up amounts. As a result, when claw-backs are factored in, the effective tax rate on dividends can be quite high.

There are strategies that can help. For example: if Old Age Security eligibility is at stake, investors can look at things that are tax-deductible as a means of reducing net income. Investment management fees, for example, can be structured to allow for deductibility. This does little for GIS recipients however, as net income is not what is used to determine GIS eligibility.

Corporate class mutual funds are another option. Unlike traditional mutual funds trusts, these are structured as corporations. The result is that there is no requirement to flow through income to the unit holders. This can be helpful from an overall tax perspective, but does little if anything to solve the dividend conundrum. In and of itself a corporate structure does nothing to shelter dividends from taxes. Unlike interest or capital gains, dividend income cannot be offset by expenses or capital loss carry-forwards, and if earned by a corporation is typically taxed within the corporation at a punitively high rate. The only way to reduce it is to not earn it in the first place!

Claw-back of benefits is something that can often be avoided with some planning, though one needs to be careful not to let the tax tail wag the investment dog. It is a good idea to understand the costs involved with investment tax strategies in order to weigh them against the potential advantages. It also helps to understand the various strategies to ensure that they actually are effective.

Investment tax planning can have a substantial impact, but the issues are complex and mistakes can be costly, consult an investment tax specialist.

Jim Grant, CFP (Certified Financial Planner) is a Financial Advisor with Raymond James Ltd (RJL). The views of the author do not necessarily reflect those of RJL. This article is for information only.  Securities are offered through Raymond James Ltd., member-Canadian Investor Protection Fund.  For more information feel free to call Jim at 250-594-1100, or e-mail at jim.grant@raymondjames.ca. and/or visit www.jimgrant.ca

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