The Secret to Tax-Free Living

After reading this article in the Globe Investor Magazine, it's no wonder why Canadian investors like Derek Foster like dividend paying stocks so much...

The secret to tax-free living
How to leverage the dividend tax break

Globe Investor Magazine, Nov. 21, 2007

THAT OLD SAW ABOUT death and taxes being inevitable is only half true: If you live in Canada, you can earn a tidy five-figure income without paying any tax. And you won't have to open an offshore bank account or work a single job under the table, because it's perfectly legal in the eyes of the Canada Revenue Agency.

How is this possible? Dividends.

Though the CRA is greedy when taxing employment and interest income, it's uncharacteristically generous when it comes to dividends of publicly-traded Canadian corporations. By taking advantage of the dividend tax credit, an investor with a sizable nest egg can live off the dividend income without sending a penny to Ottawa. Here's how.

Suppose you've worked hard, saved diligently and have a million dollars. You decide to invest the money in a portfolio of dividend-paying Canadian stocks that yields 4.5%. Let's further assume the $45,000 in dividends that rolls in every year is your sole source of income. Now, let's examine what happens to those dividends at tax time. The first thing the CRA does is apply a "gross up" to the dividends. Specifically, it multiplies the $45,000 by 1.45, for a total of $65,250. This is your taxable income. So far, things look pretty bad, right? The CRA is making it appear you earned more money than you actually did.

Including the basic personal exemption, your federal tax owing would be about $10,550. But-here's the key-because you're earning dividend income, you qualify for the generous dividend tax credit, which equals the grossed-up amount multiplied by 18.97%, or $12,375. Now for the best part: Subtract $12,375 from $10,550 and what do you get? That's right, a negative number! Translation: You don't owe any tax to the CRA. And because provinces offer their own dividend tax credits, depending on where you live you might not have to pay any provincial tax either.

In Ontario, for example, it's possible for an individual to earn up to $48,000 in dividends without forking over any federal or provincial tax, apart from a $600 Ontario health premium. In British Columbia dividend tax credits, an investor can earn up to $66,000 essentially tax-free, according to Michael Smith, an analyst with National Bank Financial. And the tax-free thresholds are set to rise over the next few years as provinces boost their dividend tax credits.

Though the tax-free dividend strategy is powerful, few people know about it, Smith says. "I've shown it to at least a dozen people in the financial industry-portfolio managers, investment bankers, analysts. Basically, they all say, 'Wow!'"

It's especially appropriate for retirees with significant savings and no other sources of income.
Now, let's look at what would happen if, instead of earning dividend income, you invested the $1 million in a bond or guaranteed investment certificate that yields 4.5%. Because interest is taxed at full marginal rates, if you live in Ontario you'd end up paying $9,050 in tax on $45,000 of income.

From a tax perspective, dividends are the clear winner. But dividends are at--tractive for another reason: Many companies-including banks, insurers, pipelines and utilities-raise their payouts once a year or more. Manulife Financial, for example, has hiked its dividend at an annual rate of about 25% over the past five years.

A bond or GIC, on the other hand, pays a fixed amount of interest. If you can stomach some volatility in the stock market and have a long-term investing horizon, dividends are the better choice, in my books.

That's why, for my own portfolio, I buy nothing but dividend stocks with rising payouts.

JOHN HEINZL is an investing reporter and columnist with The Globe and Mail's Report on Business.

S&P/TSX Canadian Dividend Aristocrats Index

Standard & Poor's launched a new index to track Canada's most consistent dividend-raisers.

The S&P/TSX Canadian Dividend Aristocrats Index is composed of Toronto Stock Exchange listed Canadian companies that have increased dividends annually for at least seven years. The index consists of 35 stocks, with each stock weighted based on its indicated dividend yield of each component stock.

The index includes all of Canada's six big banks except CIBC, which didn't increase its dividend in 2003.

S&P stated that based on back-testing, the index has produced yields ranging from 3.1 per cent to 4.2 per cent over the past five years.

The Lazy Investor - Part 2

Every since Derek Foster's Stop Working: Here's How You Can book hit store shelves in 2005, there have been critics of his early retirement strategy and questions surrounding its feasibility and the luck involved.

To follow-up on my previous post, The Lazy Investor - Part 1, in which I reviewed Foster's latest book, The Lazy Investor: Start with $50...and no Investment Knowledge, I thought it would be appropriate to present an interesting article I came across a few days ago that helps answer some of those questions.

Ellen Roseman's October 10th article in the Toronto Star provides some additional insights after her discussions with Foster.
What follows is an excerpt of Roseman's article, "Retiree, 34, helped by windfalls":

Last Thursday, he drove from his suburban Ottawa home – where he lives with a stay-at-home wife and four young children – and pulled out a stack of paper.

These were all his discount brokerage mailings going back to 1999. But since they weren't filed – or even unfolded – I wasn't going to sort through eight years' worth of transactions.

Meanwhile, the statements didn't tell the whole story. His investing career started in 1990, when he was 20. (He's now 37.)

Luckily, he'd prepared a summary. So, here's what I can tell you about Foster's strategy.

While he talks about saving and investing $200 a month over 12 years, that's just a baseline or minimum amount. He also added some windfall money (such as income tax refunds, GST credits, Christmas commissions while working at retail jobs and a pay-equity settlement).

He started with mutual funds, but now holds only dividend-paying stocks and income trusts. He's looking for companies whose products you use every day and whose shares you can hold forever.

Over time, he traded less and less. But in 1996, he borrowed money from his broker to buy Philip Morris, the U.S. tobacco manufacturer. Despite a $60,000 gain in a year, he sold the shares, fearing the company was vulnerable to lawsuits, and bought them back again later.

Still fond of leverage, he has more than $130,000 worth of stock bought on margin in his account (about 25 per cent of its current value).

He's been buying U.S. stocks that have become cheaper because of the falling U.S. dollar, such as Bank of America, Johnson & Johnson, Pfizer, Starbucks and Wal-Mart.

Why use borrowed money? Doesn't that make his strategy more risky? Well, Foster needs a tax break. His self-published books have brought in $150,000 in revenue he'd like to offset. (Interest paid on an investment loan is tax-deductible.)

And, as a self-described "control freak" who makes up his own mind, he's not afraid to take big stock positions. For example, he owns 1,000 Wal-Mart shares, now worth $45,000 (U.S.) and 700 J&J shares (worth $46,000).

Gutsy and confident, skeptical of conventional wisdom, Foster is not a typical investor. But he doesn't pretend to be. "Retiring at 34 is exceptional, as I state in my book," he says.

"However, this strategy is the surest way to early retirement without undue risk, and if readers follow this strategy and retire 10 to 15 years earlier than they thought, it's a success."

The Lazy Investor - Part 1

Self-proclaimed as Canada's youngest retiree, Derek Foster recently published his second book on his 'no thinking strategy.' I had a chance this weekend to read his latest book, The Lazy Investor: Start with $50... and no Investment Knowledge so here's a quick book review.

Compared to his first book and national bestseller, Stop Working: Here's How You Can!, Foster concentrates his efforts this time on describing how to start investing in dividend aristocrats with a small amount of cash through DRIPs and SPPs. Foster takes you through the steps to acquire that all important first share and also provides different strategies to help teach your children about the importance of money. The book also provides an update on Foster's investments and thoughts on the future of income trusts.

While I found the original Stop Working book more inspirational (probably because it introduced me to new investment strategies at the time), I would still recommend The Lazy Investor for Canadians interested in learning about investment / early retirement strategies that you probably will never hear from the so-called "financial experts."

Derek Foster's two books would make an excellent Christmas gift for anyone you think might benefit from learning a thing or two about personal finance.

Click here for "The Lazy Investor - Part 2"

"True" Yield

Leonard Zehr of The Globe and Mail posted the following article:

Going beyond dividend yield
Leonard Zehr, today at 8:50 AM EDT

Take the dividend yield and subtract the three-year compounded annual growth rate of shares outstanding. What you’re left with is “true yield,” which provides a “more comprehensive measure of how firms return capital to shareholders,” contends UBS strategist George Vasic.

By his reckoning, there are only nine stocks in the TSX composite index, with a dividend yield 1.5 per cent, a true yield of 3 per cent, no share dilution over the last three years, five consecutive dividend increases with growth of greater than 10 per cent and a payout ratio of less than 50 per cent.

They are: Methanex Corp., National Bank of Canada, Canadian National Railway Co., Manulife Financial Corp., Canadian Imperial Bank of Commerce, Bank of Montreal, Bank of Nova Scotia, Sun Life Financial Inc. and Royal Bank of Canada.

2007.5 - Way Forward Plan

With the Ontario Teachers Pension Plan and its U.S. backers, Providence Equity Partners and Madison Dearborn Partners LLC, winning the BCE auction, many Canadian investors will now be looking elsewhere to place their hard-earned dollars with most eyes likely looking at other dividend paying stocks. It will be interesting which companies will benefit the most from this large move of capital. Will it be BCE's competitors like Rogers and Telus, the banks, or the once high-flying income trusts?

One of my main strategies going forward will be to take advantage of dips in high-quality Canadian dividend paying stocks in order to develop a portfolio with reliable and steadily increasing dividend payouts.

With my recent change in employers, I will have to make changes to my RRSP and pension accounts within the next couple of months. Hence, the second half of the year is the perfect time to focus my efforts on setting out on a clear direction for my RRSP. Until now, I have contributed to my non-work-related RRSP account to reduce my income tax payments but haven't touched those cash deposits. As a result, I have missed out on a great opportunity to have my RRSP grow in value. Although, I'm still considering my options, I'm leaning towards making RRSP investments in one or two income trusts, and possibly a high-yielding American dividend paying stock. I don't have as much wiggle room inside my RRSP as compared to my non-registered account so I'll have to more disciplined in my approach.

Happy Canada Day!

Rogers Communications (RCI.B-T)

I guess I should start things off with my decision to invest in Rogers Communications (RCI.B-T) at ~$44.50 back on May 28th while it's still relatively fresh in mind.

My portfolio had a very large weighting in mining stocks and with all the talk that the TSX (particularly mining stocks) were due for a correction, I thought it would be prudent to start diversifying my portfolio.

As you can see by the 1 year chart below for RCI.B-T, it is obviously in a nice uptrend


Besides the uptrend, I found the following things interesting about Rogers:

Cable Television & HDTV:
Almost everyone nowadays is buying HDTV-ready televisions. Digital HDTV services will bring in more revenue for Rogers.

Wireless Communications:
Not only are they a key player in the wireless telecommunications industry in Canada, they will be the exclusive provider of Apple's new iPhone in the country! Once iPhone availability is officially announced, I am hoping there will be a nice spike in investor interest in Rogers.

Home Phone:
With Rogers' introduction of home phone service, many of my friends have made the switch from Bell. Apparently, their not the only ones. That's good news for Rogers; bad news for Bell.

BCE Takeover Talks:
If and when BCE gets taken over, BCE shareholders will be looking elsewhere; some might decide that Rogers is a good place to invest.

Dividend:
Although it's small, it's money in my pocket nonetheless.


I had been keeping my eye on the stock for a couple of weeks and was hoping for a pullback to $42 but thanks to the company's announcement to raise the annual dividend to 50 Canadian cents a share from 16 cents that never happened and the share price shot up on the May 28th news.

I recalled reading somewhere that the company had a good following in the United States where it just happened to be Memorial Day and their markets were closed for the holiday so I thought, "Surely, when the U.S. markets open the next day, the share will rise even further" so I placed my order. Well, I was right. The share priced opened higher the next day but unfortunately, it then quickly starting dropping again and tested the $43 mark a few times in the days afterwards.

Friday's closing price was $46.73.