Readers beware : I am not a tax expert. I am an amateur investor. Please consult an expert before making any important financial decisions.
We Canadians live in a country where there are a lot of taxes. One of the worst taxes out there is the hidden tax of inflation. But, fortunately enough, the dividend growth investing strategy has historically offered a good shelter against inflation because companies pass inflation to consumers and in turn, can increase the dividend. But, there are still a lot of taxes to handle around here.
Let’s face it. Most great dividend growth stocks are US based. To invest in the US, we, Canadian investors, face an extra risk with currency exchange. We have a lot of good dividend growth stocks prospects here too like Fortis, TD bank and so on. But except for Fortis, their strike isn’t as impressive as companies such as Exxon, McDonald’s, Wal Mart, Johnson and Johnson to name a few.
As such, I firmly believe that a great Canadian portfolio of dividend stocks in a dividend growth investing strategy should be composed of both great Canadian and US stocks to ensure proper diversification and growth prospects.
Given the fact that we face extra risks due to currency and extra headwinds due to higher tax rates, being tax efficient is more than mandatory.
Let’s see how I plan to be a successful and tax efficient Canadian dividend growth investor :
Don’t put your US dividend growth stocks in your TFSA
The first mistake many new investors make is to put their US dividend growth stocks in their TFSA account. Unfortunately, IRS does not recognize the Canadian TFSA account as a qualifying retirement account and as such, they withhold 30% of your dividend’s payments and keep them for the US treasury! So, unless you’d like to finance both the US and Canadian government, I suggest you don’t hold such stocks there!
Since it’s a tax free saving account, you won’t able to claim the tax treaty and you won’t be able to claim the foreign tax credit either here so these taxes won’t be recoverable. It’s money lost forever!
Where should I hold my US dividend growth stocks then?
I would recommend to hold them first in your RRSP account. This account is seen as a qualifying retirement account by IRS and as such, there are no tax withholding there. Your dividends can compound there tax free. When you’ll retire, you’ll pay taxes on your RRSP withdrawals like if it was normal income. So, the tax advantage here heavily depends on how long you’re going to keep your dividend stocks there for compounding. If you plan to retire very soon, holding them in a RRSP might not be that tax efficient as compounding requires years and years…
As I am in the accumulation phase and as I still have a long way to go before retiring, maximizing my RRSPs with US dividend growth stocks is my first priority.
Then, I will hold my US dividend growth stocks in my non-registered US trading account. By filling the proper form (W8BDEN), a Canadian can claim the tax treaty and reduce the IRS tax withholding from 30% to 15%. Make sure you claimed that! If not, call your broker immediately.
Then, when you’ll file your Canadian tax report, you’ll be able to claim the 15% tax paid to a foreign government as a foreign tax credit. This ensure you won’t be taxed twice on the same income.
Where to hold my REITs?
Being tax-efficient can mean, pay the less tax possible, but it also can mean, doing less complicated tax report.
REITs can give you a headache when it’s time to file your tax report. I don’t know about you but I hate complicated stuff. Why a headache? Because part of the dividend they pay you might be considered a return on capital, part can be considered eligible dividend and part can be non-eligible dividend… It’s just a mess! But gotta love the yield!
I personally hold my US dividend growth REITs in my RRSP account so I have no tax to file in and I keep my Canadian REITs and other Canadian high yield stocks in my TFSA account, that way I avoid the headache here too, plus I maximize my tax free income.
I’m currently exploring a strategy with my TFSA where I want to maximize my available contributions by investing in high yielding REITs and high yield dividend growth stocks until I reach the maximum amount I can hold in a TFSA. My goal is to receive 2500$ in tax free income from my TFSA alone within 2 years and then I’ll reinvest my dividends in other high yield but less risky and with higher dividend growth prospects Canadian dividend growth stocks such as banks and utilities. I’ll write a more in depth post about my strategy pretty soon and explore different scenarios to check if it is really an efficient strategy. The purpose here is to kick start my portfolio as soon as possible. That way I’ll be able to invest not only 5500$ per year in my TFSA account but 8000$ per year since dividends reinvestment don’t count as new additions! This is another way to be more tax efficient, but it’s a risky strategy that might not fit everyone’s profile. I got this strategy made up after reading the blog of one of my fellow bloggers 25000dividends.com.
Let’s recap my rules
Remember that I’m 33 years old with a good paying job, I am in the accumulation phase, I also have a defined benefits pension plan and I will receive income from public pension plans to which I’m contributing. As such, I can take a lot more risk than the average joe citizen!
- First, I will maximize my RRSP saving account with my US dividend growth stocks so they can compound there taxe free.
- Second, I won’t hold any US dividend growth stocks in my TFSA as IRS will withhold 30% of my dividend income and this won’t he recoverable.
- Third, using my risky strategy, I will fill my TFSA with high yield low growth REITs and high yield low growth stocks until I max out my eligible contribution (I can still invest 28,000$ there as of today). I will then reinvest these dividends plus my maximal yearly contribution in less risky with higher dividend growth prospects Canadian dividend growth stocks such as banks and utilities.
- Fourth, assuming that all my contributions to my tax advantaged accounts are maximised, l’ll hold my tax-eligible Canadian dividend growth stocks in my non-registered account.
- Fifth, assuming that my RRSP account is maxed-out, I’ll keep my US dividend growth stocks in my non-registered account and I will claim the tax treaty by filling the W8BDEN form. I will then claim the foreign tax credit on my tax report to avoid double-taxation.
Does this makes sense? Any other thoughts or tricks to share? I am not a tax expert so feel free to correct me or add any other great tricks here.
Last, while writing this post, I came across a great post written by The Canadian Couch Potato Investor. While I prefer dividend growth investing over index investing for various reasons that go beyong taxes, I also like the Couch Potato technique of investing. His post about dividends vs capital gains and taxes is a great one to read. Have a look!
Dividends are not as tax friendly as you may think – by The Canadian Couch Potato Investor
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