Dividends, Interest and Capital Gains

The governments change on taxation of dividends takes effect in 2006. Understanding the impact on your investments may take longer.

The three amigos of taxable income sources and the tax aspects can have a dramatic impact on your income. They are all sources of potential income to file on your tax return this April, yet are taxed uniquely different.

Knowing the differences and rates can save you tax this year. Without getting into a lengthy article on tax numbers, know that interest is generally taxed the highest.

For example Garth a retiree from Nanoose Bay earned approximately $31,000 last year. Regular income is taxed at approximately 25% ,interest income is taxed the same as regular income.

If his income was Canadian dividend income it would be taxed at approximately 8% compared to 25%. A large difference in tax payable on the same amount of income.

Finally capital gains are taxed at approximately 12% as only half of the gain is taxable.

Garths income is mostly pension income but he does have about $100,000 invested generating income.

Based on his tax situation investing all in dividend income would make the most sense from a tax perspective.

But dont let just taxes dictate your investing decisions. It is only one consideration.

Remember to always look at your risk tolerance. Dividends are not guaranteed, but in low interest rate times it may make sense if Garth has a higher risk tolerance than an investor all in GICs, and he may save some tax money by diversifying some of his interest income.

One such strategy is converting interest income into capital gains.

Some investment companies in Canada allow you to invest into capital class funds, which are a corporation and the interest generated inside the corporation is considered a capital gain.

That way Garth can change his interest tax cost from 25% to 12%.

Remember, all tax numbers are approximate. Check with your tax professional or financial advisor.

Comments

  1. Jacob @ My Personal Finance Journey

    Nice article! Thanks for submitting it to the Carnival of Passive Investing this month! I have been reading more and more lately about the benefits of dividend investing, and having a decreased tax rate on this form of income definitely helps convince me more of its merit.

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