Tuesday, March 28, 2006

A taxing endeavour

Given that its tax time, I've spent last two weeks talking taxes with anyone who'll listen. I've never really been mathematically inclined, and filing my return every year serves as an excellent reminder of that. So I generally try to pick the brains of anyone who'll listen, looking for tips for keeping more of my meagre earnings for myself.

In one of those aforementioned conversations, I heard something interesting I felt the need to pass on here. I must admit I don't fully understand it myself (see previous comments re: math skills) but a work colleague was telling me his theory of why its a bad move to keep dividend-producing stocks in your RRSP portfolio. The idea, if I recall it correctly, is that since dividend income is already one of the most tax advantageous forms of income there is, it's sort of a waste to "hide it" in an RRSP where the money will ultimately be taxed at a much higher rate when I redeem it.

The conversation came about because I was telling him I couldn't decide whether to put my return into a Berkshire Hathaway B share as I'd originally planned, or buy some bank stocks for the dividend income. He advised the Berkshire stock specifically because it doesn't pay dividends. He spends his dividend income outside of his retirement account, because it's already tax efficient. He says he only puts mutual funds and ETFs in his RRSP account for that reason, keeping his juicy large cap dividend stocks in a regular investment account. In a sense, he was advocating spending the dividend income as you get it because you've already paid the tax on it.

Has anyone else heard this theory? And if anyone with a background in accounting is reading this, is he right?

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Postscript Aside from this dividend debate, doing my taxes this year has reminded me of the huge advantages of RRSP's in general. Any twenty-somethings out there, take note: I know they're not sexy, and it's fun to blow all your money as it comes in. But it really does make sense to start an RRSP as early as possible. It actually pays, and I'm starting to see it with my own eyes.

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Post-Postscript I notice that FP's Jonathan Chevreau's blog entry today closely mirrors the subject of this post. I encourage you to read the article in it's entirety here, but his answer, essentially, is that RRSPs pay. So it's a no brainer for all Canadians to max out their RRSP room every year — whether in equities or elsewhere. As far as dividend are concerned, proposed changes to the way dividend income will be taxed by Ottawa may start to make a difference, and mean it could meake more sense to hold dividend stocks outside the RRSP. But until that happens, every $1 in the RRSP is a good, tax efficient $1.

1 comment:

David said...

Since all holdings inside your RRSP are taxes at your marginal tax rate on withdrawl, there is no advantage to keeping dividend & capital gains producing items in the RRSP, it will be taxed the same as interest. You still want to maximize your returns inside your RRSP by choice of suitable investments

Once you have maximized your RRSP and are looking at un-registered investments, you do not want to hold interest bearing items outside your RRSP, due to the high taxation rate on those.

David