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 The money is then taxed as income when the money is withdrawn later during retirement (presumably at a lower income tax rate).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.


I did a NETFILE once, or maybe it was a telefile (over the phone), I’m not sure. But then for many years I could not because I had some non-RRSP investments and there were some foreign dividends or something like that on them and that made me ineligible for the simpler T1 and NETFILE and telefile. So then I went back to paper returns but using software such as TaxWiz and Ufile.ca to create the return and then printing it. Nowadays, I no longer have those non-RRSP investments so I could use NETFILE but I choose not to because with NETFILE you don’t have to send in your receipts, so I figure that with NETFILE a) I’ll have a greater chance of being audited (I assume), which is a pain; b) all the receipts are with me, which means there is a danger of them all being destroyed which might be a bad thing (if I were audited); and c) there is no way for Revenue Canada to correct certain mistakes if I make one (and I have made some in the past) as they won’t have the receipts. The main advantage of NETFILE is that you get your tax refund sooner. If you don’t wait until the last minute to file a paper return you will get your refund fairly quick as well. If you are really that concerned about the quicker refund, you should consider getting your employer to take less tax off your paycheque in the first place.

Record Tax Refund

We just did some preliminary tax calculations and thanks to carried-over tuition/education amounts from previous years, and our RRSP contributions from last year, we will be getting a tax refund of around $9500. Sorry you can’t “act now to receive my amazing tax secrets.” We just had a lot of tuition credits to use, but we have now used up all our tuition/education amounts so that will be the last time we have that kind of a refund. We will either be putting that refund into our RRSPs, then reducing our monthly RRSP contributions over the next 12 months, thereby increasing the amount we can put down our student line of credit each month, OR putting it down on the line of credit thus reducing the amount of interest we have to pay on the loan each month, thereby increasing the amount of principal paid each month. Either way, it doesn’t really matter too much. I figure the risk-adjusted return on the RRSP compared to the line of credit is about the same. Although the student line of credit is at prime so the return there is really low.

Don’t Squander Your Tax Refund

A reader that goes by “David” provided a link to an article from AIM called “RRSPs versus non-registered accounts.” Here I quote part of his comment:

There are opinions all over the place on these calculations. A study published by AIM Trimark states that RRSP only come out ahead if the refund is also invested. IF the refund is used for other purposes then the un-registered investment is a better choice. RRSP vs. Non-Registered.pdf. This is what Martin Gale also states — you have to invest the whole $1000 (the $640 you have in hand, plus the refund you get).

This was my reply:

David, thanks for AIM link. Totally makes sense and thanks for bringing up the fact that the refund must be invested, not squandered. This is implicit in Martin Gale’s calculation, as you pointed out “This is what Martin Gale also states — you have to invest the whole $1000 (the $640 you have in hand, plus the refund you get).”

I am writing this blog post just to emphasize this point again. The reinvestment of the RRSP refund was implicit in Martin Gale’s calculations and I sort of missed it the first time I read the article. I understood how he used $1000 in the RRSP and $640 outside (pre-tax and post-tax amounts respectively) but hadn’t fully realized the significance. Remember that you are deferring your income tax until later. The government gives you back some tax that it collected throughout the year but you’ll need that for later, when you withdraw from your RRSP and have to declare it as income. So you better invest the tax you saved now to offset those income taxes you’ll be paying later. As “David” above pointed out, IF the refund is used for other purposes, like a new TV, then the unregistered plan is a better choice. And when we say better choice, we mean a better choice for the long term… but if you get a new TV now, that’s better for the short term (well, if you think TVs are a good thing). Like Jerry Seinfeld said when comparing medicines at the pharmacy “do I want to feel good now, or later?” I think it’s best to try to find a good balance of both.

I have written a lot of old articles having to do with putting your tax refund to good use, so I won’t belabour this point and further.

Some Retailers Absorbing 1% GST Cut

Some retailers are increasing prices by 1% rather than dropping their prices to reflect the drop in the GST from 7% to 6% according to this article: “Feds rip GST ‘cash grab’.” Rather, some retailers who include the GST in their prices are keeping their prices the same following the tax cut, such as “vendors who use all-included pricing, such as those with parking meters, candy bar vending machines and taxis.” I don’t see the big deal here. If we take it to the extreme, let’s say I am running a business that sells hybrid cars for $30,000 (I make a profit of $3,000 on each car sold). The government collects 7% GST let’s say. That’s $2100 for GST. So the total cost to the customer is $32,100. Let’s imagine that the government removes GST from hybrid cars as an incentive for customers to buy hybrid cars. So now the cost to the consumer is $30,000. If I want to charge $31,000 (increasing my profit from $3,000 to $4,000) I should be able to do that and there should be nothing stopping me from doing so (assuming capitalism reigns). Flaherty, our Finance Minister called “a decision by the Toronto Parking Authority, which oversees about 50,000 parking spots in the city, to not change fees at its garages and street meters” “outrageous.” I would not be surprised if sales taxes actually have an effect of depressing base prices on goods and services whereas lack of sales taxes can cause prices to go up. Thinking back to problems in profit maximization we solved back in first-year calculus, this only makes sense.

Tax Refund Finally Applied to Loan

Our tax refunds have finally arrived. It took over a month but that’s to be expected since we filed in April and filed paper returns (printed out from software of course). Over $4700 for the two of us. I have transferred the entire amount against the principal of our student loan. That makes a small dint in the loan but it will reduce our interest payments by about $20 per month. That is not huge, but that is $20 per month for many years to come, not just this year. My wife will also be receiving a one-time retroactive hiring bonus of on the order of $4500 so that is another $20/month savings on interest and next year we can get another $20/month from another tax refund. It will feel good to lower those monthly payments, leaving more room in our monthly cash flow for something like a mortgage payment in the future.

Currently we are just paying interest on the student loan every month. The reason is that our monthly cash flow is pretty tight now. All our money is going somewhere, whether it be RRSP and savings and the amount of disposable cash we have available is very limited. Rather than using the one-time debt payments to lower our interest payments and thus increase the amount of principal paid down every month (ie. constant monthly payments) thus shortening the amortization period, we have decided to take the $20/month savings and we will allocate that to one of our ING savings accounts. Ideally, if we could afford it, I would love to be able to pay interest and principal on the loan every month but it just cannot be done right now. Maximizing our RRSPs is our #1 concern, and I think that is the right thing to do as I expect the return in my RRSP to exceed the interest rate on the loan and secondly, the tax refund every year can be applied towards the loan’s principal anyways.

Use Your Tax Refund (a.k.a. savings) To Build Your Wealth

Great article from Clearsight called “Use Your Tax Refund To Build Your Wealth.” I have not really found many of Clearsight’s articles to be that insightful but this one was. I particularly liked their discussion about the different types of expenditures:

Three types of expenditures
Ultimately, whatever you do with your money can be broken down into three basic categories of expenditures.

No-value expenditures
For some expenses, once your cash is used the money is gone. Things like food, utilities, clothes, entertainment, etc. These expenditures do not contribute to building wealth. This category includes necessary expenditures (like food) but sometimes also far too many unnecessary expenditures (like entertainment). Filling your cash flow with too many unnecessary things is often fun — but not productive.

Depreciable expenditures
In this category, the item you purchase may have value, but that value depreciates over time. The most common depreciable expenditure is a car. Most of us consider a car an asset because it has value, but every year, the car we own has less and less value. Cars depreciate, and often faster than we would like them to. Obviously, a depreciable asset is better for wealth building than a no-value expenditure because it at least contributes to our net worth.

Appreciable expenditures
Using your money in this category is the most productive for wealth building. Assets like GICs, real estate, stock portfolios and bonds, go up in value over time. Using your cash flow for these types of investments will be the most fruitful use of your money. Often, they are not as fun or exciting as spending money on that new big-screen TV or fancy car, but it is the best for improving your financial picture.

This is a great read for anyone. A tax refund is an asset and you can transfer than into a appreciable asset, a depreciable asset, or an expense. They left out a fourth option, which is to transfer it into a liability, but this is similar to “appreciable expenditure” above. They go on to talk about net worth,

A key benchmark in your financial planning is your net worth. Your net worth is simply what you own minus what you owe. A primary goal of your financial planning should be to increase your net worth year over year.

As for the tax refund and what you should do with it:

The answer should be the same answer to, “What should I do with my cash flow?” The best thing to do with your tax refund is to use it productively — towards building your net worth. You may think all of this is really simple and full of common sense. If that’s the case, then why don’t more people do it? It’s not easy to do. Financial planning is all about trade-offs and discipline. The people who succeed are the ones who just do it!

It seems like a no-brainer to transfer your tax refund into an appreciable asset (see “Appreciable expenditures” above) first. Maybe even just an ING Direct Savings account. You can always make a “no-value expenditure” from that asset later. For me just getting money out of my hands works wonders. Any incoming cash flows I receive, gifts, tax refunds, web design work, adsense revenue goes straight into some form of savings account. Once the money is in the savings account, I think carefully about making expenses from it because I have saved up that money and I do not want it to go to waste. I become attached to that money. This thought process is completely bypassed when I cash a cheque or deposit it directly into a chequing account.

Canada Revenue Agency’s “My Account”

The CRA (Canada Revenue Agency) (which by the way was called the CCRA (Canada Customs and Revenue Agency from 1999 to 2003) has had some form of “My Account” service for a while now. In recent years it has gotten a lot better. You can now access:

  • Notice of changes and summary of assessment or re-assessment in full
  • Previous returns in full from 2003 onward. Information on refunds and filing dates is available going back to 1999.
  • Carryover amounts (such as tuition and education amounts and net capital loss carry forwards)
  • Account balace
  • Information about instalments
  • Current direct deposit information on record
  • Home Buyer’s Plan/Lifelong Learning Plan information
  • RRSP deduction limit and unused contributions available to deduct
  • GST and Child Tax Benefits information
  • Request changes to prior years’ returns.
  • Register formal disputes.
  • Change your address or phone numbers.

Essentially everything that is provided on those notice of assessment forms every year is now available online.

It has also gotten harder to log on to. One used to be able to log in quite easily by providing a social insurance number, a birthdate, and some information from prior tax returns (amount on line 150). Now you need to go through a more in-depth registration process. This requires you to get an ePass, a username and password which gives you access to various government services. I also used my ePass to apply for a new Canadian passport online last year (applying online allows you to jump the queue at the local passport office). CRA also requires you to type in an activation code that they will mail out to you.

Fortunately, their website now works with Firefox (despite a warning that it does not) which it did not last year. If you still have problems and you are using Firefox, try upgrading to Sun Java 1.5 (JRE 5.0).