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Capital gains and dividends within and outside RRSP
August 7, 2018
8:45 pm
Norman1
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Loonie said

I haven't looked it up recently, but I have a relative who gets GIS and we do their tax returns. My recollection is that GIS is not included in taxable income. On the other hand, you can't get it if your income is above something-or-other, no more than 25K for a single person. My recollection is that the GIS itself is reduced at 50 cents on the dollar for every additional dollar of taxable income above the minimum for receiving it in the first place, but it could be net income. I have always found that part a bit confusing. I don't see that it has anything to do with the dividend income per se.
Nobody receiving GIS is going to have an income greater than about 25K, so I don't understand what you are saying about the 43K.
It may be that this is all over my head as I am still lost!

Could be I misunderstood the question asked and wrote an answer to a different question? sf-laugh

I think I have the right period of time: After one starts collecting CPP, OAS, and maybe GIS.

My understanding is that GIS clawback begins at $0, excluding OAS. Each $1 of income means 50¢ of reduction in GIS. Like a 50% tax on the income.

If the income were eligible dividends, I'm not sure if the GIS clawback would be 50% of the $1 of actual eligible dividend received or 50% of the grossed up $1.38 that is the taxable dividend.

$0 to about $25K range, out of the $0 to $43K range, is where one could receive GIS and where one would face 50% GIS clawback as the result of the dividends.

$25K to $43K is where there is negative taxation in Ontario for eligible dividends.

August 7, 2018
9:13 pm
Loonie
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Norman1 said

$0 to about $25K range, out of the $0 to $43K range, is where one could receive GIS and where one would face 50% GIS clawback as the result of the dividends.

$25K to $43K is where there is negative taxation in Ontario for eligible dividends.  

Agreed. I think we're "on the same page" now. I was a bit confused by the clawback language as I don't think of GIS as being clawed back since it only exists to bump up very low income seniors to a basic income, hopefully enough to live on. It's not a universal fixed amount like OAS. However, I can see where the gross-up could interfere.

People in the $25K - $43K category are not going to get GIS regardless, although it's conceivable that some, at the lower end, could lose because of the gross-up affetling GIS. However, if stocks are their only other source of income other than CPP/OAS and they are in a low income category like this, they would be well advised to get out of stocks in my opinion anyway. It's too risky for someone in that situation at that age. If they're smart, they'll see that the dividends are costing them more than they're worth, plus the risk factor.

GIS is based on "net income", so I think that would include the gross-up, yes? However, I don't think very many people with income that low will be getting dividends.

For the people in the $25-43K category in Ontario, we have agreed that the dividends would attract a negative rate. This in turn would trigger a credit against taxes owing in most cases because I would think most people in that category pay income tax.
Would you not agree, then, that for these people, they would be better off with dividends outside the RSP? This is assuming they never had high incomes, excludes the eventual impact of capital gains for the moment, and doesn't deal with the question of tax deduction for RSP vs tax on withdrawal, as it's too complicated and too many variables.

August 8, 2018
6:00 pm
Norman1
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Yes, anything based on Net Income (line 236) will be based on the grossed-up dividends and not the actual dividends.

Yes, for the dividends alone, it would be better that they be earned outside an RRSP or a TFSA when their taxation is negative. But, dividends don't usually come alone.

Dividends are associated with stocks which also come with capital gains. Would it then be better to have

  1. negatively taxed dividends and taxed capital gains or
  2. zero taxes on both dividends and the capital gains?

The person would have #2 if the person has been within that bottom $0 to $43K tax bracket all that time, both when making their RRSP contributions and now doing the withdrawals.

August 8, 2018
8:54 pm
Loonie
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It's only an observation but it seems to me that most people essentially never sell their good dividend producers - particularly the senior population we've been talking about, who see it as an income stream.
And, in this particular case, there would be no motivation to do so; why mess with something that's working well?

It also seems that a lot of people don't care about what's left over when they die or the ultimate tax liability. It seems that many RSP/RIF holders are content to let the estate pay 50% tax.

I didn't quite follow how you got to zero tax for $43K (but willing to assume you're right) , but I think the people who see dividends as an income stream and don't care about final disposition would want #1.

August 9, 2018
6:29 pm
Norman1
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Not necessarily. Many of the desirable dividend paying stocks also grow their dividends as the company grows.

For example, the Bank of Montreal shares I bought long ago were paying $2 a year each share at the time. Since then, the shares have split twice and the dividend is now $3.84 per split share or $3.84 x 2 x 2 = $15.36 a year per original share. That will cause capital gains as the share price is pulled upwards by the rising dividends.

Should the dividends eventually grow by 15%, about 13% of the shares could be sold if the extra income is not needed.

I got the zero tax for $43K from the person being in the same 20% Ontario tax bracket ($0 to $43K bracket). If the person remains in the 20% tax bracket, then the person received 20% tax refunds on the RRSP contributions and pays 20% on the RRSP withdrawals. When the rate on the refunds matches the rate on the RRSP withdrawals, no net tax is actually paid on any gains.

August 9, 2018
9:49 pm
Loonie
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I don't know much about capital gains, but I thought you only had to pay tax on them when you sold your stock. If you gain more shares by splits, then I would think you have gained, not sold. If dividends go up , then they're still dividends, not capital gains. No?

Something else that I don't think we've considered is the impact of the gradually increasing minimum withdrawal rates on RIFs - for those who are taking out the minimum. If you live long enough, they get quite high. Perhaps there is some thought that the principal will decrease over time and it will all work out, but that depends on a lot of things. Point is that RIF income is not stable and probably not predictable unless you put into an annuity. Another moving part!

August 10, 2018
7:57 am
Bill
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True, a stock split per se does not create an income tax event.

Norman1, you say "When the rate on the refunds matches the rate on the RRSP withdrawals, no net tax is actually paid on any gains." Can you explain that more? To me, if I contribute $100 to my RRSP and it grows to $120 via capital gain I pay tax on the $20 capital gain portion too, not just the contribution amount, on withdrawal, regardless of rates at time of contribution and withdrawal.

August 10, 2018
11:10 am
AltaRed
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You need to take into consideration the tax deduction you got when you made your contribution. On a net basis, you contributed perhaps $80.

August 10, 2018
12:42 pm
Bill
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AltaRed, I put $100 in, got $20 (20%) refund, took $120 out, paid $24 taxes. That seems to me to be paying tax on the capital gain.

August 10, 2018
4:42 pm
AltaRed
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Seems to me you put $80 in ($100 less $20 tax refund) from your left pocket, and got $96 out ($120 less $24 taxes paid on the $120) to put in your right pocket. You made $16 net gain.

Easier example: No gain at all. You put $80 in ($100 minus $20 tax refund), got $100 out and paid $20 in taxes on the $100, for a net of $80.

August 10, 2018
6:02 pm
Bill
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AltaRed, exactly, there are $4 of taxes to pay on the $20 capital gain. I was saying that I didn't understand Norman1's comment that there are no net taxes on any gains if rates stay the same but your calculations show that you only get, after taxes, $16 of the $20 gain.

August 10, 2018
6:48 pm
Norman1
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Keep in mind that 20% of the $20 gain ($4 of the gain) is from the government's $20 share of the $100 in the RRSP.

When you made the $100 contribution while in the 20% tax bracket, the government refunded 20% x $100 = $20 of the $100 as a result of the RRSP contribution deduction. So, one ends up with an RRSP that looks like this:

$20 Government net contribution
$80 Bill's net contribution
$100 Total

After growing by 20%, the RRSP looks like this:

$24 Government's portion
$96 Bill's portion
$120 Total

When all the funds are withdrawn while still in the 20% tax bracket, one sends the government 20% x $120 = $24 in income tax. That ends up being just the government's $24 portion of the RRSP! One gets to keep the $96 which is the original $80 plus 20% capital gain.

Consequently, the original $80 net contribution is returned to you tax free. Also, you receive the 20% capital gain of $16 free and clear of tax! sf-cool

That works out to be exactly the same as putting $80 in a TFSA, earning 20% capital gain ($16), and withdrawing the resulting $96 tax free.

August 11, 2018
7:00 am
Bill
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Ok, got what you mean now.

August 11, 2018
8:32 am
Norman1
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The net taxation of RRSP earnings is quite an interesting revelation.

I read about it earlier in Globe & Mail article Investor Clinic: Beware of these three RRSP myths by John Heinzl.

David Chilton discusses the same in the chapter "Battle of the Abbreviations" of his book The Wealthy Barber Returns. He references this table "Net Proceeds From Saving in a TFSA Relative to Other Savings Vehicles" from Annex 4 of Budget 2008:

Net Proceeds From Saving in a TFSA Relative to Other Savings Vehicles
  TFSA   RRSP Unregistered
Savings
Pre-tax income 1,000 1,000 1,000
Tax (40% rate) 400 400
Net contribution1 600 1,000 600
Investment income (20 years at 5.5%) 1,151 1,918 7072
Gross proceeds
(Net contribution + investment income)
1,751 2,918 1,307
Tax (40% rate) 1,167
Net proceeds 1,751 1,751 1,307
Net annual after-tax rate of return3 (%) 5.5 5.5 4.0
1 Forgone consumption (saving) is $600 in all cases. In the RRSP case, the person contributes $1,000 but receives a $400 reduction in tax, thereby sacrificing net consumption of $600.
2 For unregistered saving case, tax rate on investment income is 28%, representing a weighted average tax rate on an investment portfolio comprised of 30% dividends, 30% capital gains and 40% interest.
3 Measured in relation to forgone consumption of $600. Assumes annual nominal pre-tax rate of return is 5.5% invested for 20 years.
August 11, 2018
8:46 pm
Norman1
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Loonie said
I don't know much about capital gains, but I thought you only had to pay tax on them when you sold your stock. If you gain more shares by splits, then I would think you have gained, not sold. If dividends go up , then they're still dividends, not capital gains. No?

That's correct. There is no immediate capital gains realized on a split. But, the reason there was a stock split was the stock price went up substantially. That means substantial unrealized gains that will one day be realized and taxed when not within an RRSP or TFSA.

Something else that I don't think we've considered is the impact of the gradually increasing minimum withdrawal rates on RIFs - for those who are taking out the minimum. If you live long enough, they get quite high. Perhaps there is some thought that the principal will decrease over time and it will all work out, but that depends on a lot of things. Point is that RIF income is not stable and probably not predictable unless you put into an annuity. Another moving part!  

That's the RIF withdrawal rate intended to wind down the tax benefits of the RIF. One doesn't need to spend the entire RIF withdrawal each year if one doesn't need the money. One could still invest any unneeded funds from the RIF withdrawals but without the tax benefits of a RIF.

August 12, 2018
6:37 am
Loonie
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Norman1 said

That's the RIF withdrawal rate intended to wind down the tax benefits of the RIF. One doesn't need to spend the entire RIF withdrawal each year if one doesn't need the money. One could still invest any unneeded funds from the RIF withdrawals but without the tax benefits of a RIF.  

The context of the question was around RIF income and taxes due on it being variable.
What one does with the proceeds is a separate issue.

On the question of capital gains from dividend-producing stock, I was considering the people who intend not to sell and not to trigger capital gains; they intend to use the dividends as income stream and leave it for their estate to work out unless they should need the money for medical expenses, where they will expect a large offsetting tax credit. This seems to be the opinion of many on this forum and it is paired with those who are content to leave large sums in their RSP/RIFs at death. Both methods attract a lot of taxes and, on the surface at least, the non-RSP capital gains would appear to draw less tax than the RRSP ones, but that might be exactly true on further investigation. By the time you add in capital losses, which get no credit at all in RSPs, it is again complicated and unpredictable.

August 12, 2018
9:20 pm
AltaRed
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I doubt many retirees have the luxury of a portfolio large enough to avoid having to sell appreciated stock in a non-registered portfolio on an ongoing basis. In these cases, capital gains will be realized as appreciated stocks have to be sold to fund living expenses on an ongoing basis.

It is a fairly elite group who could live off the dividend income alone and leave a non-registered 14tock portfolio with huge appreciated gains to the estate to be taxed in one lump sum.

That said, capital gain tax rates are currently 50% of the tax rates of Other Income, e.g. from RRIFs, so the lump sum tax bite on death of last surviving spouse would be less. A workable strategy might be to deplete an RRIF in an orderly fashion before death to spread the tax hit over multiple years. Now only if we knew when our expiry date would be, eh?

August 14, 2018
3:29 pm
savemoresaveoften
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Our income tax structure is setup so that u either do really well in life and ends up paying high tax ur entire life, or u do really average and able to reap some benefits of delayed taxation benefits of RRSP.

For my particular case, I did really well in my RRSP having accumulated dividends, interest and capital gain in my RRSP. When I need to start withdrawing, every dollar out will be taxed as income. No real tax deferred benefits after all since losing capital tax treatment of 50% and dividend tax credit...

Whoever designed the tax system is a genius....

August 14, 2018
9:04 pm
AltaRed
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savemoresaveoften said
Whoever designed the tax system is a genius....  

It is because the RRSP was intended to be a black box. It has to be that way to avoid taxation within.

If it really perturbs you, keep your growth assets (subject to cap gain) outside the RRSP and even your eligible dividend assets. But note that you will be paying tax on realized income on 'as you go' basis.

It cannot be both ways.

August 19, 2018
9:53 am
Norman1
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Loonie said

… Both methods attract a lot of taxes and, on the surface at least, the non-RSP capital gains would appear to draw less tax than the RRSP ones, but that might be exactly true on further investigation. By the time you add in capital losses, which get no credit at all in RSPs, it is again complicated and unpredictable.

That will attract taxes but not necessarily net taxes. One will have negative taxation on the capital gains should the taxes on the later RRSP/RRIF withdrawals be reduced by, for example, medical expense credits.

Take the previous example of 20% tax rate at contribution time with 20% gain. At the start, the RRSP looks like this:

$20 Government net contribution
$80 Bill's net contribution
$100 Total

After growing by 20%, the RRSP looks like this:

$24 Government's portion
$96 Bill's portion
$120 Total

If, because of credits like medical expense credit, one ends up sending in 18% out of the 20%, then one sends the government 18% x $120 = $21.60 in income tax. One ends up keeping $24 - $21.60 = $2.40 of the government's $24 portion of the RRSP!

Consequently, the original $80 net contribution is returned tax free. The 20% capital gain of $16 is returned free and clear of tax. $2.40 is returned on top of all that.

That ends up being a net tax of -$2.40/$16 or -15% on the $16 capital gain that was inside the RRSP! sf-cool

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