Dividend Stocks Inside vs. Outside an RRSP

In this article, “Dividend tax breaks make blue-chips a wise buy” in the Toronto Star (linked from the Canadian Capitalist), Ellen Roseman says:

Buying blue-chip Canadian stocks can be a good strategy for do-it-yourself investors. I’m talking about the big banks, insurers, pipelines, telephone companies, gas and electrical utilities that pay dividends of 2 per cent to 4 per cent a year.

This is similar to what you earn on a high-interest savings account or fixed-term deposit. But if you hold these stocks outside of a registered plan, your income is worth more because of the tax breaks on dividends.

It almost sounds as if she is saying that, given the choice, you should hold dividend investments outside of a registered plan (RRSP) rather than inside. I think what she is saying is that if we just compare dividend stocks with interest-bearing investments such as term deposits and high-interest savings accounts, if they are both held outside of an RRSP, less tax will be paid on the dividends than on the interest from the other investments. However, dividend stocks should never be held outside an RRSP if one still has contribution room inside one’s RRSP. Putting dividend stocks inside an RRSP eliminates the taxes on the dividends. Instead, pre-income-tax dollars are invested inside the RRSP where it can grow tax free. The money is then taxed as income when the money is withdrawn later during retirement (presumably at a lower income tax rate). The double taxation of dividends/interest is avoided.

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10 Responses to “Dividend Stocks Inside vs. Outside an RRSP”


  • Thanks for the link Dave. I agree with you if the tax paid on dividends is say 20% but dividends even attract a tax credit for many tax brackets. For them, it may be advantageous to hold dividend stocks in a taxable account even when RRSP room is available.

  • Ah, true I forgot about the different tax brackets.

    For those making under $37,885 they effectively have a negative tax rate on the dividend portion of their income. For those making more than that, this doesn’t apply. Also if proposed taxation changes take effect, by 2012 the negative marginal tax rate will disappear.

    Dividend tax credits
    Why is there sometimes a negative marginal tax rate for dividends for lower income tax brackets?

  • In some provinces, there are no taxes on dividends until your income exceeds about $68,600. Since I currently live happily on less than that net income now, it would be quite easy in the future, provided the tax structure paces inflation. And, if you never sell the shares, your estate pays the capital gain.

    Also, you have to look at the cost-benefit of an RRSP contribution. There are many who will not benefit from an RRSP, as their income upon retirement will be taxed at a higher rate than while working. Many of us do NOT max out our RRSPs for that very reason, and only use them in high taxation years to reduce taxes.

    DAvid

    DAvid

  • DAvid, you’re right! Here’s another link for everyone:

    Marginal Income Tax Rates for Canada for 2007 and 2008 in different provinces

    In my own province of BC, there are no taxes on dividends until your income exceeds $70,033. It looks like BC has the best dividend treatment of all provinces!

  • Dave and David, excellent points.

    I love solid dividends and it makes sense to hold Canadian dividend-paying stocks outside of a RSP. As you have indicated, one can earn a great ‘tax-free’ income from Canadian Blue Chips.

    International dividend income could be held within an RSP.

    What to hold in a TFSP?

  • Assetologist, if your employment income or other income sources puts you in a higher tax bracket, then it makes more sense to put dividend-paying stocks inside an RRSP (assuming you have the room). If you hold them outside you will be paying tax twice, once on your income and a second time on the dividends. If you put it in an RRSP you pay tax once, at the end when you take it out.

    In a TFSP, well from a tax perspective I think anything is fine. You put after-tax income into a TFSP and you take out after-tax income with the capital gains/interest/dividends and pay no double-taxation. I’d say that if you had more money leftover after the TFSP and the RRSP then (depending on your province) dividends might be the way to go (better tax treatment than capital gains and interest), but the easiest way to find out is to just find out the marginal tax rate for each.

  • Ok guys, good points…what is your advice on a couple who will have each have a 60 to 70 percent pension upon retiring who currently have average salaries before taxes at 60 K

    Should we continue to contribute to RRSP’s at the rate of about 6K a year (max contribution) or should we stop contributing to RRSPS total value after being hammered by stock market is at approx 100k
    and each contribute to the tfsa (3k each) and hopefully purchase blue chip, high divident companies.

  • Dave,

    In brief and in a concise manner, can you tell me if I should buy and hold my canadian dividend-paying stocks inside my RSP or outside, in only my discount brokerage account?

    I’ve read many-a-book on investing, and it appears there are many folks for and against both options.

  • “Dividend stocks should never be held outside one’s RRSP if one still has contribution room inside one’s RRSP”

    That’s the most concise I can make it. In an RRSP, interest, dividends, and capital gains are effectively not taxed. Outside, they are. So outside is always worse than inside.

    If your RRSP is maximized then you need to decide what to invest in outside your RRSP. You don’t want to just consider taxes, you want to consider risk, return, and taxes. Dividends, interest, and capital gains are all taxed slightly differently. All other things considered equal, you want to have the things that are taxed most favorably outside the RRSP and the rest inside.

  • Another thing that many have missed out on is that when you buy a blue chip stock say for $100 and sell it for $150 the $50 profit is considered a capital gain and you only have to pay tax on $25.

    However, if you hold that same stock in a RRSP, not only are now having to pay tax on dividend income (which for a lot of people would be tax free) you are also having to pay tax on the entire capital gain.

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