Being Financially Independent Retire Early in Canada // What Happens to Income Tax Return?

A while ago, I wrote a piece called Our Financial Independence Assumption…What About Taxes? In it, I took a close look at what our taxes might look like if we were to live off dividend income. Since tax season is upon us (this year you have to file your 2017 income tax return by April 30), I thought it would be fun to run some scenarios to prepare us for financial independence. What if we were financially independent in 2017 and lived off dividend income? What happens to our 2017 Canadian income tax return?

Rather than base everything on assumptions, I will use some actual numbers from 2017.

Disclaimer: I’m not a tax specialist. This post is simply my interpretation of the Canadian income tax system. Please consult a tax specialist regarding your income tax.

2017 Spending – Real Data

Rather than use $40,000 as our annual spending, we will take a look at real data from 2017. In 2017 we spent a total of $51,144.77, excluding any business expenses.

A quick breakdown of some of our 2017 expenses

  • We spent $33,887.68 in Necessities
  • We spent $17,257.09 in Give, Play, Education, and Vacations
  • We spent  $1,104.08 in fitness for Baby 1.0 (swimming)
  • We spent $3,905 in childcare (preschool) for Baby T1.0
  • We spent $1,492.20 in fitness for Baby T2.0 (swimming, children’s gym)
  • We donated $850 to charities (about $250 less than previous years because local Christmas Bureau didn’t match us up with a family in time for Christmas giving).

For the sole purpose of this article, we will use these real data from 2017 on our tax returns.

Income Tax Assumptions

We will pretend that we were financially independent in 2017 and lived off dividend income for the entire year. This means we needed to have received $51,144.77 in dividend income in 2017. For mathematical simplicity, we will use $55,000.

Once we are financially independent, we won’t be contributing to RRSP. So another assumption is that we made $0 in RRSP contribution in 2017. (And therefore, no RRSP deduction).

We plan to withdraw from our RRSPs and perhaps collapsing our RRSPs before we turn 71. There are tax consequences when withdrawing money from the RRSP. Therefore, we need to come up with a withdrawal strategy. Our RRSP withdrawal strategy is to split the withdrawal amount between the two of us. Below are the RRSP withholding tax rates:

We will assume that we are splitting our RRSP withdrawals. We plan to withdraw less than $5,000 a year to limit the withholding tax amount. Therefore, for the 2017 income tax return simulation, we will assume that we each withdrew $4,990 in 2017 while paid 10% ($499) in withholding tax. We would net $4,491. The $4,491 is then considered as active income when filing for 2017 income tax return.

Our 2017 Dividend Income Breakdown

In 2017 we received a total of $14,834.38 in dividend income. The dividend income breakdown between RRSP, TFSA, and Taxable as below:

  • RRSP: $5,589.46 or 37.68%
  • TFSA: $5,760.84 or 38.83%
  • Taxable: $3,484.08 or $23.49%

But this breakdown will probably quite different once we are financially independent.

For this particular post, we will assume that we received $55,000 in dividend income to cover our 2017 expenses. Since we withdrew $4,990 each from our RRSPs, we needed $45,020 in dividend income from TFSA and taxable accounts. And let’s assume the TFSA and taxable account dividend income breakdown was roughly 30-70, or that we received $13,520 in dividend income from TFSA’s and $31,500 from taxable accounts.

Let’s also assume that Mrs. T and I had a 50-50 split on the $31,500 taxable dividend income, or $15,750 each. And all the dividends received were eligible dividends.

2017 Taxes – Scenario 1

For the first scenario, we will assume that we didn’t make any active income and we had no business income in 2017. The numbers would look like:

My Taxable Income:

  • $15,750 in dividend income
  • $4,491 from RRSP withdrawal

Taxes I Paid:

  • $499 from the 10% RRSP withholding tax

Mrs. T’s Taxable Income:

  • $15,750 in dividend income
  • $4,491 from RRSP withdrawal

Taxes Mrs. T Paid:

  • $499 from the 10% RRSP withholding tax

Our Deductions:

  • $1,104.08 in Fitness for Baby 1.0
  • $3,905 in Childcare (preschool) for Baby T1.0
  • $1,492.20 in Fitness for Baby T2.0
  • $850 donation to charities

Note 1: In 2017 the children arts & fitness credits were eliminated federally but some provinces still have such credit. In BC we still have a $500 credit per child.

Note 2: Based on the 2017 enhanced dividend tax credit rates, we need to gross-up $15,750 dividend received by 38% ($21,735). We would get a dividend tax credit of 20.73% of the actual dividend amount received ($3,264.98).

I used Simple Tax to find out what our tax returns would look like for 2017.

And our T1’s would look like:

And Schedule 1

Both of us would be able to recover the $499 RRSP withholding taxes!

Scenario 1 Total Income Summary: $55,000

  • $13,520 in dividend income from TFSA’s
  • $31,500 in dividend income from taxable accounts
  • $8,982 from RRSP withdrawal
  • $998 from tax refund

Scenario 1 Total 2017 Taxes Paid: $0

And we paid $0 in taxes. We would also be eligible to receive an estimated $823.92 in tax-free Canada child benefit per month ($9,993.84 per year).

Nice!

How much would our portfolio need to worth to receive this kind of dividend income? For TFSA’s to produce $13,520 in dividend income and taxable accounts to produce $31,500 in dividend income, at 4% yield rate, we would need our TFSA portfolio to worth $338,000 and taxable portfolio to worth $787,500. Or $1,125,500 in total. 

2017 Taxes – Scenario 2

In scenario 2, let’s assume the same numbers as scenario 1 but Mrs. T and I made a modest $10,000 revenue each in our side businesses.

My Taxable Income:

  • $15,750 in dividend income
  • $4,491 from RRSP withdrawal
  • $10,000 in business income

Taxes I Paid:

  • $499 from 10% RRSP withholding tax

Mrs. T’s Taxable Income:

  • $15,750 in dividend income
  • $4,491 from RRSP withdrawal
  • $10,000 in business income

Taxes Mrs. T Paid:

  • $499 from 10% RRSP withholding tax

Our Deductions:

  • $1,104.08 in Fitness for Baby 1.0
  • $3,905 in Childcare (preschool) for Baby T1.0
  • $1,492.20 in Fitness for Baby T2.0
  • $850 donation to charities

Interestingly, this would result in a different balance owing for the two of us.

Mrs. T would have to pay $328.42 in taxes. I would have to pay $144.50 in taxes. This is because I would claim the child care expenses.

 Scenario 2 Total Income Summary: $74,002

  • $13,520 in dividend income from TFSA’s
  • $31,500 in dividend income from taxable accounts
  • $20,000 in business income
  • $8,982 from RRSP withdrawal

Scenario 2 Total Taxes Paid: $1,470.92

  • $998 in RRSP withhold taxes
  • $472.92 owed

That would be a 2.43% tax rate (exclude $13,520 from TFSA’s in this calculation). Plus we would qualify for about $669.11 of Canada child benefit each month. A really low taxrate considering our combined taxable income was $60,482.

2017 Taxes – Scenario 3

What if we were to make $25,000 in dividend income and make $10,000 in business income each while keeping the same income from TFSA’s and RRSP’s?

My Taxable Income:

  • $25,000 in dividend income
  • $10,000 in business income
  • $4,491 from RRSP withdrawal

Taxes I Paid:

  • $499 from 10% RRSP withholding tax

Mrs. T’s Taxable Income:

  • $25,000 in dividend income
  • $10,000 in business income
  • $4,491 from RRSP withdrawal

Taxes Mrs. T Paid:

  • $499 from 10% RRSP withholding tax

Our Deductions:

  • $1,104.08 in Fitness for Baby 1.0
  • $3,905 in Childcare (preschool) for Baby T1.0
  • $1,492.20 in Fitness for Baby T2.0
  • $850 donation to charities

The gross-up amount would be $34,500 and $5,182.5 for the dividend tax credit.

As you can see, I would owe $144.50 in taxes and Mrs. T would owe $504.37 in taxes.

Scenario 3 Total Income Summary: $92,502

  • $13,520 in dividend income from TFSA’s
  • $50,000 in dividend income from taxable accounts
  • $20,000 in business income
  • $8,982 from RRSP withdrawal

Scenario 3 Total Taxes Paid: $1,646.87

  • $998 in RRSP withhold taxes
  • $648.87 income taxes

Or a 2.14% tax rate. It’s a bit odd that we would pay a lower tax rate in scenario 3 than scenario 2.

For TFSA’s to produce $13,520 in dividend income and taxable accounts to produce $50,000 in dividend income, at 4% yield rate, we would need our TFSA portfolio to worth $338,000 and taxable portfolio to worth $1,250,000. Or $1,588,000 in total. 

2017 Taxes – Scenario 4

What if we had no business income at all and received $25,000 in dividend income each from our taxable accounts?

My Taxable Income:

  • $25,000 in dividend income
  • $4,491 from RRSP withdrawal

Taxes I Paid:

  • $499 from 10% RRSP withholding tax

Mrs. T’s Taxable Income:

  • $25,000 in dividend income
  • $4,491 from RRSP withdrawal

Taxes Mrs. T Paid:

  • $499 from 10% RRSP withholding tax

Our Deductions:

  • $1,104.08 in Fitness for Baby 1.0
  • $3,905 in Childcare (preschool) for Baby T1.0
  • $1,492.20 in Fitness for Baby T2.0
  • $850 donation to charities

And the tax filing would look like

Pretty neat to see that we would get 100% of our RRSP withholding taxes back.

Scenario 4 Total Income Summary: $73,500

  • $13,520 in dividend income from TFSA’s
  • $50,000 in dividend income from taxable accounts
  • $8,982 from RRSP withdrawal
  • $998 in tax refund

And we paid $0 in taxes once again!

Based on our 2017 expenses, a combined income of $73,500 would give us $22,355.23 buffer or 30.4%. I think that’s a lot of buffer room to cover unexpected expenses.

Final Thoughts

By using real-life expenses from 2017 and creating four different scenarios with some realistic assumptions, once again I have confirmed that it is indeed possible to live off from dividend income when we are financially independent.

Another thing that I have confirmed is that dividend income is very tax efficient, even if you make a modest amount of active income. Having kids has also allowed us to receive some deductions.

If we were to make more “active’ income when we are financially independent via businesses and side hustles, another way to reduce our taxes is to take out more dividend income from our TFSA’s and relying less on dividend income from taxable accounts. For example, maybe a 50-50 split between TFSA and taxable, or even a 60-40 split.

As you can see, when we are financially independent, there are quite a number of parameters we can play with to allow us to effectively pay $0 in taxes while sustaining our current lifestyle. While paying $0 in taxes  (legally through deductions and such) is the goal, I have no problem paying taxes to make sure we can continue to receive the excellent social benefits of being a Canadian.

From a dividend income perspective, we still have some work to do. But it is very encouraging to see we are making good progress and breaking our monthly dividend income record consistently.

Written by Tawcan
Hi I’m Bob from Vancouver Canada, I am working toward joyful life and financial independence through frugal living, dividend investing, passive income generation, life balance, and self-improvement. This blog is my way to chronicle my journey and share my stories and thoughts along the way. Stay in touch on Facebook and Twitter. Or sign up via Newsletter