Long time readers will know that my wife and I are deploying a hybrid investing strategy – we invest in both dividend paying stocks and index ETFs. It is our goal to have our portfolio generating enough dividend income to cover our expenses. When this happens, we can call ourselves financially independent and live off dividends. By constructing our portfolio and selecting stocks that grow dividends each year organically, we believe our dividend income will continue to grow organically and keep up with inflation so we don’t have to ever touch our principal.
In the past, I have done a few simulations showing that living of dividends is possible and that dividend income is very tax-efficient in Canada. But simulations are full of assumptions and the numbers can change. Wouldn’t it be nice to showcase someone that is living off dividends already?
As luck would have it, Reader B, a fellow Canadian, recently mentioned that he retired in 2004 at age 55 and has been living off dividends since. I was very intrigued by B’s story when he told me that he worked as a civil engineer and his wife worked as an administrator.
I fell off the chair when he told me that he and his wife started investing with $10,000 and have amassed a dividend portfolio that generates over $360,000 in dividends each year!
That’s $30,000 a month! Holy cow!
While working, they had above average salary (B made ~$110k and B’s wife made ~$90k in today’s money). The high household income has certainly helped them build the dividend portfolio. But I believe a lot of it is due to B and his wife’s living modestly – not a lavish lifestyle but not penny pinching either.
After a bit of emailing exchanges, he agreed to answer my questions about his experience with living off dividends (it took a bit of convincing haha!). I truly believe B’s knowledge will help a lot of dividend growth investors.
Note: B’s original reply was over 11,000 words not including my comments (our email exchanges were very long too). I went through his answers and edited some parts out. For ease of reading, I have decided to split the post into two posts.
I hope you’ll enjoy this Q&A as much as I did.
Living off dividends – How I’m receiving $360k dividends a year and paying almost no taxes
Q1: First of all, B, thank you for participating. It’s wonderful to learn that you and your wife have been retired since 2004 and have been dividend investors for over 36 years.
A: Thank you, Bob, for giving me the opportunity to share my 36 plus years of dividend investing experience and results with you and your readers. After following your blog, I realized that we and many others were on the same dividend investing path. The only difference being that I was a few more years along in the investing journey. I felt others might benefit from my experience with dividend investing.
You’re on the right path, Bob, and given your rate of progress to date by the time you reach my age (72) you will certainly attain your dividend income goals and likely well beyond. So I wanted to encourage you to continue along the dividend investing path. It’s a very sound and profitable strategy.
I’m more than happy to share with others a few of my ideas on dividend investing and how it can be done in a tax-effective manner.
Q2: How long have you been investing in dividend paying stocks?
A: I started investing in stocks in 1985. After the initial period of learning the ropes and finding my way in the investing and stock market world, it was only in 1990 after subscribing to a weekly investing newsletter that I finally saw the investing light and found that dividend investing was right for us.
So I guess you could say I’ve been traveling along the dividend paying stock road for some 31 years now. And we’ve been comfortably supplementing our lifestyle with an ever increasing stream of dividends since we retired in 2004 to the present day.
Diving into the dividend portfolio
Q3: How much dividend income are you getting each year? Can you provide a detailed breakdown across non-registered and registered accounts?
A: As of April 30, 2021, my wife and I are receiving $360,000 in combined pre-tax dividend income annually – that’s $30,000 per month – and still growing.
Our combined assets are distributed as follows:
- RRIFs: 8.2%
- TFSAs: 1.9%
- Non-Reg Dividend Income Accounts: 85.5%
- Other Short-Term Liquid Assets: 4.4%
So the amount we have in registered tax-sheltered plans totals 10.1% and is decreasing annually in compliance with RRIF mandatory withdrawal requirements.
These figures illustrate a problem that can develop gradually over time – a severe imbalance between registered and non-registered accounts caused by the low contribution limits governing registered savings plans. Allowable contributions to registered plans are capped.
If one’s savings levels exceed the cap limits by a significant amount, then the balance between registered and non-registered accounts can tilt heavily towards the latter. The effect is that registered plans then become less and less significant in the overall account mix. This unbalanced effect means that we now have only 10.1% of our assets in tax sheltered accounts while 85.5% is held in “unsheltered” non-registered accounts.
So that makes it critical to find ways to ensure that holdings in non-registered accounts are as tax efficient as possible. The most optimum way to achieve tax-efficiency under such conditions is to focus on buying and holding Canadian dividend paying stocks in non-registered accounts.
We will continue to shift portions of our “other” assets toward Canadian dividend income as we go forward.
Our non-registered accounts are producing the entire $360K dividend income stream referenced above. The annual yield on market value is 4.2%. The actual yield on cost is much higher than the market yield. Our portfolio has returned nicely over the years.
Our annual mandatory RRIF withdrawals are the minimum required by age and proceeds are immediately re-invested in more dividend stocks and held in our non-registered accounts. We do not touch our TFSAs and contribute the maximum allowable amount each year.
Tawcan: My jaw dropped when you told me about your $360k a year dividend income. That is absolutely amazing!
At 4.2% yield that means the market value of your portfolio is over $8.5M! Obviously your yield on cost would be much higher than that given you have invested over 30 years. Regardless, I’m betting that the cost basis of your non-registered portfolio is in the multi-million dollars range. It is very impressive considering you and your wife only made around $200k a year in today’s money.
The Dividend Investing Philosophy
Q4: Can you give us an idea of your general approach to dividend investing?
A: My dividend investment philosophy can be summed up as: “To buy gradually over time, high-quality Canadian tax-efficient dividend paying stocks and hold them indefinitely.”
I buy stocks gradually in roughly equal amounts and spread the purchases over time. I never invest large lump sums all at once. I’ll take an initial position in a stock, usually in the $10K value range, and then return again at an opportune price point and buy some more (i.e. dollar cost-averaging).
High quality stocks are selected – conservative large cap stocks – most often dividend aristocrats – minimum 2% yield with the odd exception for superior growth stocks or those with growth potential. Great focus is placed on buying dividend aristocrats and stocks in the TSX Composite 60 Index with a nod toward following the Beat the TSX strategy.
Tawcan: Funny B mentioned the BTSX strategy. Check out Matt, the brain behind Beating the TSX strategy, and his family’s amazing story about traveling the world with 4 kids.
I exclusively buy only Canadian stocks – no USA stocks – none – no exceptions. The only US stocks I would consider are those that have a TSX listing and can be purchased in Canadian dollars for tax efficiency reasons.
Tawcan: It’s interesting that you only hold top Canadian dividend stocks and no US or international dividend paying stocks or ETFs.
All our stock buys must be held in non-registered accounts – contributions can not be made to RRIFs and our TFSA contribution room is maxed out. My wife and I also invest in REITs and they require special attention (more on that later).
All stocks we buy must pay a dividend. As mentioned, I usually insist on a 2% yield or higher – but not too high. One never wants to over-reach for yield which is often the warning sign for an impending dividend cut. If a stock does eliminate its dividend, then it’s automatically gone from our portfolios and we move on to another stock that does pay a reliable dividend.
Once a stock is safely and appropriately tucked into our portfolios, we just sit back and hold it “forever”. One can then enjoy living off the ever increasing dividend income stream while watching the stock appreciate in capital value over time. We still hold stocks that we bought back in 1985 like BMO and BCE.
On very rare occasions, it may be advisable/necessary to sell a stock for the following reasons:
- When a stock’s prospects have taken a downward turn.
- In the event of a takeover bid – friendly or otherwise – one often has little choice but to sell.
- For tax-loss selling purposes. We seldom pay any capital gains income tax at all. When we do realize a capital gain from a stock sale, then we’ll sell another stock (or partially sell) to realize an offsetting capital loss. But tax-loss selling is not usually done at year-end along with “the herd”. After waiting the mandatory 30 days and if the stock remains a solid investment, then we will often buy the stock back – hopefully at a lower price.
Under a buy and hold strategy, there is not a lot of opportunity for capital gains. By not selling, no capital gain is realized and so capital gains tax can be deferred indefinitely.
On the other hand, dividend income can be extremely tax efficient when you are income splitting between two people. We’ll get into the specifics a bit later.
Q5: You mentioned that REITs require special attention. What did you mean by that?
A: Not all REITs are equal in terms of tax efficiency when held in a non-registered account where taxes on REIT distributions can vary from 0% to 53.53% (in Ontario). Therefore, the most tax-efficient place to hold a REIT is in a registered account.
REIT distributions often have different income type components with each type having a different tax rate. The best REITs to hold in a non-registered account are those having a high percentage of their distributions classified as “Return of Capital” (ROC).
ROC is a tax deferred capital gain distribution which lowers the REIT’s Adjusted Cost Base (ACB); this means that tax payment is deferred until the REIT is sold at which point the amount of tax payable is calculated using one’s preferred (and lower) capital gain tax rate. Some REITs have a high “Other/Foreign” income type classification in their distributions which means much of the distribution will be taxed away at one’s highest tax rate.
The better option with tax-inefficient REITs in non-registered accounts is to sell them or avoid them entirely and simply invest the funds in a much more tax efficient Canadian eligible dividend paying stock. Handling REITs and ensuring they are tax-efficient is more complicated for sure.
Tawcan: This is why we only hold REITs in our TFSAs and RRSPs to avoid the complicated tax consequences. If you’re holding REITs in your taxable accounts, it makes sense to pay special attention to these details.
How to find dividend investing resources
Q6: What sources of information do you rely on to help you in making your stock selections and managing your dividend portfolio?
A: Back in 1985 when we started on our investing journey, we didn’t have the Internet. Everything had to be done via a phone call to your broker. At that time, one’s primary source of investment information came from the print media – newspapers, books, financial magazines and investment newsletters galore.
From 1985-1989, I realized that I was floundering around in the investing environment. I had no direction and no real objectives. The stock selection was pretty much hit and miss with mediocre success and usually only slightly more winners than losers. I did not yet realize that focusing on dividend paying stocks was the best investment plan to follow.
Then I found the publication that finally gave me the investing direction and purpose I needed – focusing on dividend paying common stocks!
I subscribed to a newsletter called “The Investment Reporter” (not a referral link) in 1990. I still have an uninterrupted subscription to this publication some 31 years later. The eight page report is delivered to me weekly by mail.
They have been publishing for 79 continuous years now and are still going strong. This publication is a perfect fit for conservative dividend investors like myself.
I also read extensively (both on-line and print) on economics, business, politics, investment and taxation. There are many excellent on-line blogs and investment advice sites. Fellow investors are always willing to share their experience.
Tawcan: This is why I love this community so much. People are so willing to share their knowledge and help each other out.
An equally valuable source of information is your online discount web brokerages. There are many discount brokers to choose from and some promote themselves on the basis of their low transaction fees. As long as one is not paying more than $10 per transaction, one should not be swayed by the lure of low fees when choosing an on-line discount broker.
Tawcan: This is why I really like Questrade and Wealthsimple Trade. Check out my real user Questrade vs. Wealthsimple Trade review here.
What you want from a broker is an efficient, robust and reliable trading platform. But you also want access to top-notch, extensive market/stock research and stock analytical reports. And you need a variety of research tools (screeners, watchlists, news/price alerts, etc.) – and all hopefully offered free-of-charge with your brokerage account.
Research capabilities and tools should really be your primary consideration when choosing your on-line discount broker – not just low transaction fees.
Tawcan: You can also find many resources in my Dividend Investing FAQ.
Q7: Do you rely on any analysis methods to assist in selecting dividend stocks to buy? How do you buy and avoid overpaying for your dividend stocks?
A: I use a combination of both fundamental and technical analysis. Fundamental to assess stock fair value metrics and attractiveness as an investment. Technical to assist in timing a price entry point.
The two go hand-in-hand and complement each other. On the technical side I try to keep things simple. The main stock price technical indicators I rely on are: 13 and 40 week moving averages and crossover points, the 14-week Relative Strength Index, and 40-week two standard deviation Bollinger Bands.The latter two indicators I find to be particularly good at identifying stock overbought and oversold conditions.
Tawcan: I also went through some methods on how to start dividend investing. It’s interesting to note that you use the 13 and 40 week moving average and crossover points. That’s certainly one of the techniques that I use regularly.
Here are a few practices I have found useful in buying and selling stocks:
- I never ever buy on margin.
- I don’t employ options (they introduce another variable … time & date).
- I never sell short
Just keep it simple – buy or sell “long” which means the holder owns the underlying asset. I place only day orders and set a limit price. I never use stop loss or stop limit orders.
And here’s a key point – don’t get overly obsessed with price by trying to save a penny or two on your orders.
Let’s say you’ve found a stock that will make a solid investment. You’re going to buy and hold it for the long term and you like the dividend yield at the current market price. A penny or two either side of the market price is not going to have any significant impact on your stock holding long-term!
I’ve learned this lesson the hard way. Too often in my early investing days I’d try to skimp on my offer price to save a penny only to miss getting the stock entirely. Then to my dismay, now empty in hand, I’d watch the stock rise from that point to great new heights while leaving me behind – yet another stock that got away.
Trying to save a penny a share I lost the opportunity to make a dollar a share. It’s called “the cost of a missed opportunity”. Not the most brilliant investment move to make.
Here’s another way to look at the price of a stock transaction. At any given price, there is a buyer and a seller. Tomorrow, one is going to be proven right and the other wrong – a 50-50 chance in the short-term. The only thing certain is that tomorrow the price will change.
If I’m right and the price goes up, I’m happy. If I’m wrong and the price goes down, then I will buy additional shares later at lower price levels. This is called “dollar-cost averaging” and I’m a firm believer in the strategy.
Long-term, stock market prices trend upwards; by averaging down with additional share purchases we can be reasonably confident that in the long-term our solid stock picks will eventually rebound upwards and bring us even greater profit.
Tawcan: Great stuff B! I’ve certainly made the same mistake before! If you plan to hold a stock over the very long term, it’s silly to save a penny or two on the purchasing price.
Dividend investing – How to minimize taxes
Q8: You’ve mentioned that taxation and the minimization of taxes on your dividend income stream and capital gains is a very important aspect of portfolio management. How do you accomplish this?
A: A good and important question. Minimizing taxes is a vital component of dividend stock portfolio management to ensure that we maximize our returns. After all, it’s the $$$ left in your pocket (after the taxman takes his cut) that counts.
So we need to structure our dividend income stream, capital gains and registered plan withdrawals to minimize the tax payable. The term I like to use is “tax-effectiveness” i.e. how effectively have we structured our portfolio holdings, stock buy/sell transactions, registered account withdrawals, etc. in terms of minimizing our annual income tax bill.
Every investor/taxpayer has the right to organize their portfolio in ways that, while adhering to tax laws and regulations, minimizes the amount of income tax they have to pay. One needs to be well-read on methods/strategies for making one’s portfolio tax-effective and above all be knowledgeable in the tax rules that apply to your specific type of investments and the accounts they are held in.
Tawcan: Completely agree with you. I am all for paying taxes but it is important to figure out how to be as tax efficient as possible.
There are two essential pieces of information one needs to know before any tax planning can be done – they are specific to your level of income, portfolio make-up and overall tax situation.
Firstly, you must know your income types and how much of each income type you receive annually. There are three main types of income:
- Canadian eligible dividends
- Capital gains
- Other/earned/interest income.
I sometimes refer to the latter as “straight income” because it is fully taxed at your marginal tax rate. There are many other types of income such as foreign income and foreign dividends. But for taxation purposes these other types usually fall into the “straight income” category.
Secondly, you need to know the Marginal Tax Rate (MTR) for each of your income types. The MTR tells you how much tax must be paid on each new income type dollar that you earn. As an example, at high income levels (> $220K in Ontario), the maximum MTR on “Other” income is 53.53%, on eligible dividend income it is 39.34% and on capital gains it is 26.76%.
MTRs decline as one’s income falls in lower tax brackets. At high income levels, capital gains are the most tax-efficient type of income to have while dividend income attracts a 13% higher tax rate but still well below the full taxation rate applied to “other” income.
At lower levels of income, the situation totally reverses and dividend income is taxed at zero to extremely low levels.
So how can you take advantage of the marginal tax rates and make dividend income investing tax-free? (Note: All numbers quoted here are for the province of Ontario but most other provinces are in the same general range.)
A single person who has $55,300 of pure/sole Canadian eligible dividend income will pay virtually no tax and enjoy an MTR of 0.56% on dividend income at that level. In contrast, if the person’s $55,300 was in the form of capital gains income then the tax payable would be $1,604 (with an MTR of 10.03%). And if the person’s $55,300 was in the form of straight (other) income then the tax payable would be a whopping $8,752 (with an MTR of 32.66%)!
This shows quite dramatically that at lower income levels, Canadian eligible dividends are an extremely tax efficient source of income as opposed to capital gains and even more so when compared to straight income.
Carrying this example a bit further, the situation gets even better for a couple because the dividend tax-free income levels double. A couple who has $110,500 of pure/sole Canadian eligible dividend income will also pay virtually no tax and enjoy an MTR of 0.56% on dividend income. In contrast, if the couple’s $110,500 was in the form of capital gains then the tax payable would be $3,347 (with an MTR of 10.02%). And if the couple’s $110,500 was in the form of straight (other) income then the tax payable would be $17,621 (with an MTR of 32.66%)!!
It is this nil taxation feature of Canadian eligible dividends at low income levels that gives us the basis for our strategy of living tax-free off dividend income.
A single person can make approx $55,300 and a couple $110,500 in Canadian eligible dividend income (and that’s actual dividend income – not grossed up) and pay practically no tax on that income.
So for tax-efficient planning, it is essential that you know your income level, income types and MTRs.
Tawcan: I knew that dividend income can be extremely tax efficient but it’s cool to see you lay out in a couple of examples. It is very beneficial for couples to split their eligible dividend income as a way to effectively lower their income tax.
Q9: Are there any “tools” or evaluation methods that you rely on to assess and check for tax effectiveness?
A: The best tool you can find is your income tax preparation software. Rough manual calculations are okay but the many on-line tax calculators give you only an approximation of taxes owing and have practically no customization capabilities – so I don’t use them at all.
My preferred income tax software package is “UFile”. This program is impressive, easy to use, displays results clearly and is also super easy to adapt as a scenario tester.
For example, after you’ve completed and Netfiled your taxes, find the file in which your tax software has stored/saved your data (In UFile it’s the *.u20 file for 2020 taxes). Make multiple copies of the file renaming each file to identify the tax scenario you wish to test. Click on the new renamed file and it should open in your software package and immediately display your current tax situation as you Netfiled it. Add in an additional $100 of “Other Income” on a new blank T3 or T5 slip and recalculate the tax owing. The results will show you the precise amount of additional tax you will have to pay on that extra income or an RRSP withdrawal.
Make adjustments to other income levels – up or down as you forecast them to be for the coming tax year. Test another scenario by increasing the RRSP withdrawal amount to $15K and see what happens. Using this method you can quickly assess the tax-effectiveness of any combination of income types, amounts and portfolio adjustments you might want to consider.
You can enter your coming year forecast for income types and amounts and get an accurate calculation of the amount of tax you will owe specific to your situation.
Your annual income tax software (desktop version) is the most powerful tool you can use for accurately assessing tax scenarios specific to your situation. Use the results to guide your investment decisions going forward into the new year.
Tawcan: Great advice. I’ve used Wealthsimple Tax for many years (previously called Simple Tax). You can certainly do similar calculations by setting up a test account. Their simple online tax calculator already does a decent job at estimating the tax consequences but doing full tax estimate simulations with the program is the best way to do it. I highly recommend everyone to run some simulations with an income tax software.
Wrapping it up – Living off dividends
Thanks B for sharing your amazing story and your knowledge with us. There are a lot of things to digest here. As mentioned, since the Q&A is quite long, I decided to break it into two parts. We will continue with the second part next week.
Dear readers, I hope you have enjoyed this Q&A session so far. Stay tuned next week for the rest of the Q&A
Check out Part 2 of the Living Off Dividends Interview.
* A few readers have pointed out that the “paying almost no taxes” part in the title is a bit misleading. Perhaps a little. What I wanted to show and what Reader B has demonstrated is that dividend income can be very tax efficient, even in a high dollar amount.