Revisit our Financial Independence Assumptions

3 years ago, I first wrote about our financial independence assumptions where I estimated how much we would need to be financially independent. Later, I wrote a post on what our income tax might look like when we are financially independent. I created 3 different scenarios with different levels of income. The conclusion I had was that if we rely mostly on our dividend income to cover our expenses when we are financially independent, we would be paying very little taxes.

Now 3 years later, I thought it would be worthwhile to revisit this topic. I would like to compare these assumptions to our historical annual expenses and determine if the assumed numbers are still valid. Since I’m a numbers nerd, as a fun exercise, I would examine the different income tax scenarios again.

Our Financial Indepence Assumptions

Below are what we assumed our core expenses per month might be when we are financially independent.

  • House property taxes $350
  • House maintenance $50
  • House insurance $100
  • Utilities $100
  • Internet & cellphones $100
  • Groceries $800 – two growing kids
  • Healthcare $150
  • Household supplies $100
  • Clothing $100
  • Car insurance for 1 vehicle $120
  • Gas for 1 vehicle $50
  • Car maintenance $50
  • Buffer $200

Total: $2,270.

Since our core expenses do not include things like eating out, charity donations, entertainment, vacation, etc, we will add $950 per month to cover these non-core expenses.

This results in $3,220 per month in expenses, or $38,640 per year. For simple calculation, we will round this number up to $40,000.

So, to be financially independent, we need our dividend portfolio to produce $40,000 per year. While we do plan to continue some part-time work when we are financially independent, dividend income will be the primary source of income.

Our Historical Annual Expenses

Let’s take a look at our historical annual expenses over the last 7 years.

 Total Necessities SpendingCore Necessities Spending per MonthTotal Annual SpendingTotal Spending per Month
2012$26,210.52$2,184.21$44,603.76$3,716.98
2013$26,343.00$2,195.25$45,260.88$3,771.74
2014$29,058.96$2,421.58$47,391.96$3,949.33
2015$31,256.88$2,604.74$47,270.16$3,939.18
2016$29,831.40$2,485.95$4,7566.96$3,963.91
2017$33,887.68$2,823.97$51,144.77$4,262.06
2018$31,840.75$2,653.40$57,231.99$4,769.33

For the last 3 years, we have been averaging $2654.44 per month in core expenses. That’s about $400 more than our FI assumption core expense. This is not too far off, considering we assumed that when we are financially independent, either of us would be working full-time. So some expenses, like car-related expenses, for example, should go down.

In the last 7 years, we have never spent less than $40,000 in a year. While I do think $40k a year annual expenses is achievable, I want to be realistic. When we are financially independent and working part-time (or not working at all), we probably will be travelling more. This will most likely increase our overall spending.

Therefore, for all intents and purposes, let’s run a few different scenarios using the following annual expenses

  • $40,000 a year
  • $50,000 a year
  • $60,000 a year


Income Tax Comparisons

For calculating income tax, I used the trusty 2018 tax calculator by SimpleTax. All the calculations are based on BC residency. I also assumed that there were no tax deductions available.

If you are earning income via employment, below are the employment income you need to earn to supplement the 3 different annual expenses.

Annual
Expenses
Employement Income NeededTaxesAverage Tax RateMarginal
Tax rate
$40,000$50,776.00$10,776.000.21%28.20%
$50,000$65,003.00$15,00323.08%28.20%
$60,000$78,930.00$18,930.0023.98%28.20%

In comparison, below are the dividend incomes you need to supplement the 3 different annual expenses.

Annual
Expenses
DividendNet IncomeTaxesAverage Tax RateMarginal Tax Rate
$40,000$40,000.00$40,000.00$0.000%28.20%
$50,000$50,000.00$50,000.00$0.000%28.20%
$60,000$60,000.00$59,797.00$203.0034%31%

As you can see from above, The Canadian tax system is very favourable to people that rely on their dividend income. If you are earning income via employment, your income is taxed way higher than dividend income.

Our Dividend Income Breakdown

In 2018 we received a total of $18,734.29 in dividend income. The dividend breakdown from the different accounts was as follow:

  • $7,062.92 from RRSPs or 37.7%
  • $6,802.49 from TFSAs or 36.3%
  • $4,868.88 from taxable accounts or 26.0%

In our previous financial independence assumptions, we assumed that Mrs. T and I would have a 40-60 split in dividend income. Was this realistic? Let’s take a look at a further breakdown of our 2018 dividend income.

AccountsMrs. T%Tawcan%
RRSP$1,182.616.3%$5,880.3131.4%
TFSA$3,154.8116.8%$3,647.6819.5%
Taxable$1,616.628.6%$3,252.2617.4%
Total$5,954.0432%$12,780.2568%

So our 2018 dividend income was more of a 30-70 split between the two of us.

Because Mrs. T didn’t become a Canadian permanent resident until 2011, she did not have TFSA contribution rooms for 2009 and 2010 ($10,000 in total. As you may recall, we had mistakenly over-contributed her TFSA and had to beg the CRA for mercy). Therefore, it makes sense that her TFSA doesn’t generate as much dividend income as my TFSA.

Since I already have a sizable RRSP, thanks to working for 12 years at the same company, we have started a spousal RRSP for Mrs. T in recent years. I have stopped contributing money to my self-directed RRSP. Instead, I am now contributing money to Mrs. T’s spousal RRSP. Our ultimate goal is that one day our RRSPs would roughly have similar in value and generate similar amount of dividends.

Ideal Dividend Income Breakdown

Given that I’m the primary income earner in our household (for now), it might not be realistic to assume that our dividend income would be a 50-50 breakdown. I think a 40-60 breakdown as we previous assumed is more realistic.

Based on 2018 dividend income breakdown, and the fact that we are slowly adding more money to Mrs. T’s spousal RRSP and her taxable account, below is the ideal/assumed account breakdown when we are relying on dividend income cover our expenses.

AccountsBreakdown
Mrs. T Taxable10%
Tawcan Taxable15%
Mrs. T TFSA17%
Tawcan TFSA20%
Mrs. T RRSP13%
Tawcan RRSP25%

Based on the above breakdown, below would be the dividend incomes we expect to receive in the different accounts.

AccountsBreakdown$40,000$50,000$60,000
Mrs. T Taxable10%$4,000$5,000$6,000
Tawcan Taxable15%$6,000$7,500$9,000
Mrs. T TFSA17%$6,800$8,500$10,200
Tawcan TFSA20%$8,000$10,000$12,000
Mrs. T RRSP13%$5,200$6,500$7,800
Tawcan RRSP25%$10,000$12,500$15,000

With these numbers in hand, we can calculate the different tax scenarios.

Withholding Tax on RRSP Withdrawals

A very important thing to note regarding RRSP withdrawals is that any withdrawals from your RRSP are immediately subject to withholding tax. The amount of withholding tax is based on how much you are taking out. The final amount you get is then taxes at your marginal tax rate.

Another thing to note is that non-residents of Canada pay a withholding tax of 25%, except in places where the amount is reduced by treaty. So if we decided to live outside of Canada when we are financially independent, we’d be taxed at higher rate when we make withdrawals from our RRSPs.

Income Tax Assumptions

Below are some of the assumptions I will use for income tax calculations

  • All dividends from taxable accounts are eligible dividend income.
  • We will make withdrawals from our RRSPs on the full amount listed in the table above.
  • No tax deductions (i.e. charitable donations, RRSP contributions, business expenses, etc).


Scenario 1 – $40,000 Tax Calculations

What happens to our income tax if Mrs. T and I were to receive a combined $40,000 in dividend income from the different accounts?

Accounts ($40,000 Scenario)Mrs. TTawcan
Taxable$4,000$6,000
TFSA$6,800$8,000
RRSP$5,200$10,000
RRSP Witholding Tax$1,040$2,000
Net RRSP$4,160$8,000
Est Refund$1,040$2,000
Average Tax Rate0%0%
Marginal Tax Rate20.06%20.06%
Net Income$16,000$24,000
Total Income$40,000
Using SimpleTax 2018 Calculator

We wouldn’t pay any income tax. Pretty cool! This was expected.

Scenario 2 – $50,000 Tax Calculations

What happens to our income tax if Mrs. T and I were to receive a combined $50,000 in dividend income from the different accounts?

Accounts ($50,000 scenario)Mrs. TTawcan
Taxable$5,000$7,500
TFSA$8,500$10,000
RRSP$6,500$12,500
RRSP Witholding Tax$1,300$2,500
Net RRSP$5,200$10,000
Est Refund13002500
Average Tax Rate0%0%
Marginal Tax Rate20.06%20.06%
Net Income$20,000$30,000
Total Income$50,000

Once again, we would be paying $0 in taxes if we were to receive $50,000 in dividend income and use that money to cover our expenses. This was what I expected.

Scenario 3 – $60,000 Tax Calculations

Below are the calculations if we were to receive $60,000 in dividend income.

Accounts ($60,000 Scenario)Mrs. TTawcan
Taxable$6,000$9,000
TFSA$10,200$12,000
RRSP$7,800$15,000
RRSP Witholding Tax$1,560.0$4,500.0
Net RRSP$6,240.0$10,500.0
Est Refund15604500
Average Tax Rate0%0%
Marginal Tax Rate20.06%20.06%
Net Income$24,000$36,000
Total Income$60,000

I’ll be honest, I wasn’t expecting to pay $0 in taxes for scenario 3. I was expecting that we would need to pay a small amount of taxes.

It was interesting to see that we can receive $60,000 in dividend income combined without paying any taxes. On the other hand, we’d need to pay around $14,000 in taxes if one of us were to earn $60,000 in employment income. We’d need to pay around $6,500 in taxes if one of us were to earn $36,000 in employment income.

Note: Although we wouldn’t be paying any income taxes in these 3 scenarios, we would still be paying taxes like GST, PST, property tax, carbon tax, transportation tax, etc. We wouldn’t be “freeloading.” 🙂 😉

Scenario 4 – $60,000 living abroad Calculation

Since we plan to live abroad like Taiwan and Denmark when we are financially independent, what will happen to our income tax? For this scenario, I will assume that we receive $60,000 in dividend income.

Accounts ($60,000 living abroad)Mrs. TTawcan
Taxable$6,000$9,000
TFSA$10,200$12,000
RRSP$7,800$15,000
RRSP Witholding Tax$1,950.0$3,750.0
Net RRSP$5,850.0$11,250.0
Est Refund$1,950$3,750
Average Tax Rate0%0%
Marginal Tax Rate20.06%20.06%
Net Income$24,000$36,000
Total Income$60,000

Wow, that was interesting! Even if we were to live abroad when we are financially independent, and pay 25% in withholding tax for RRSP withdrawals, we would still net $60,000. Very cool!

Scenario 5 – dividend & working calculation

Just for fun, what happens if we were to receive $50,000 in dividend income and we were to work part-time? Let’s assume that we made $10,000 each in part-time income from our side businesses ($20,000 in total). For simplicity, we will assume that we have no business deductions.

SimpleTax Calculator hard at work…
Accounts ($50k Div + $20k Bus)Mrs. TTawcan
Taxable$5,000$7,500
Employement Income$10,000$10,000
TFSA$8,500$10,000
RRSP$6,500$12,500
Total Income$30,000$40,000
RRSP Witholding Tax$1,300$2,500
Net RRSP$5,200$10,000
Est Refund$875$906
Average Tax Rate4.33%5.80%
Marginal Tax Rate20.06%20.06%
Net Income$29,575$38,406
Total Income$67,981

We would be paying $1,781 in taxes combined at a marginal tax rate of 20.06% and average tax rates of 4.33% and 5.80%. These are pretty small percentages if you were to ask me. In reality, we could probably deduct a lot of business expenses to reduce the amount of taxes we have to pay.

How much do we need?

While going through these different scenarios, I began to wonder how much money is needed to generate the required dividends in the different accounts. Below is the breakdowns based on a 4% dividend yield.

Money needed in different accounts to generate desired dividend incomes

For my TFSA, the accumulated total amount is $63,500 from 2009 to 2019. For Mrs. T, the accumulated total amount is $53,500 from 2011 to 2019. Looking at the different scenarios, at $6,000 contribution each per year, it would take quite a number of years to hit more than $170k in our TFSAs. Maybe our assumptions are not realistic?

It’s tough to answer this question. One thing to note is that the values indicated in the table above are portfolio values rather than total contributions. Therefore, it may not take as many years to hit these numbers as our portfolio value should increase thanks to dividend income and capital appreciation.

In general, I am encouraged to see these number breakdowns. The money needed is roughly in line with what we anticipated. Again, these are “portfolio values.” Thanks to organic dividend growth and DRIP, we may not need to contribute over $1M as I explained previously.

Final Thoughts

Phew, that was a lot of numbers that we just went through! From the 5 different scenarios, I have validated once again that dividend income is very tax efficient. In fact, we wouldn’t be paying any income tax if we were to rely purely on dividend income to cover our expenses. I was quite surprised that this is the case even in the $60,000 per year dividend income scenario. Even if we were to work part-time, earning $20,000 a year between the 2 of us, we would be paying a very small amount of income tax. And I am totally OK paying taxes, given that we would be using the great social benefits available to Canadians.

When I originally created 3 different scenarios in 2016, I was quite worried about the withholding tax on RRSP withdrawals. Therefore, in those scenarios, I made the RRSP withdrawals to be below $5,000. In this post, I have demonstrated that we don’t really need to worry about RRSP withholding tax when our combined dividend income is below $60,000. This was quite unexpected.

Another interesting thing to note is that even if we were to decide to live abroad when we are financially independent and living on $60,000 of combined dividend income a year, we would be getting all the withholding tax back when we file for income tax.

Therefore, I continue to believe that dividend income can be quite tax efficient, especially during FIRE years when one is not earning employment income. Relying on dividend income provides a margin of safety, too, as we wouldn’t need to touch our principal.

Dear readers, what do you think about my assumptions? If you see any holes in my calculations and assumptions, I would very much love to hear from you.

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