# Avoiding dividends to reduce OAS clawback



## dotnet_nerd (Jul 1, 2009)

I'm approaching retirement and am putting together a plan. I read Daryl Diamond's book "Your Retirement Income Blueprint". What an eye-opener.

I never realized how detrimental dividends can be (in a non-registered account) due to the gross-up. $10000 in dividends results in $13800 net income which impacts OAS/GIS clawbacks.

Example - suppose I plan to withdraw $10000 from the non-registered portion of my portfolio; a 'total portfolio' approach.

Method A)
withdraw $10000 from the proceeds of dividends


Method B)
Sell $10000 worth of stock right before ex-div

Tax consequences:
A) results in net taxable income of $13800

B) results in a capital gain which will only be taxed at 50%. But this is offset by the fact that I can buy the stock back and reset the ACB so the next cap gain will be less. 
(Or possibly no capital gain whatsoever. I might be cutting losses on some loser.)


Ideally, one could mark ex-div dates on the calendar and dodge dividend payouts.


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## like_to_retire (Oct 9, 2016)

Yes, the income wouldn't suffer from gross-up, but it does seem like a lot of work with perhaps a 20 stock dividend portfolio?

What about the cost of all those trades?

Every time you sell and buy back the same stock, you lose the capital gain tax deferral. Over many years, capital gain tax deferral could be a significant savings.

If someone has enough income to trigger OAS clawback, isn't the $7217 a year that OAS pays fairly insignificant?

I know when I am about to sell a stock that I will look at the ex-date and usually try and sell to take the built-in dividend as capital rather than taking the dividend, but I was selling anyway, and why not optimize it, but to continually churn my stocks would be a bit much. I just accept the clawback.

ltr


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## OptsyEagle (Nov 29, 2009)

It is quite annoying. The gross up is the governments attempt to ensure that there is little or no double taxation when it comes to corporate income trickling down to the personal level. Great good job. The problem, as you have pointed out, is this gross up of taxable income creates a whole slew of new tax and benefit problems. Since almost all of the problems either increases the tax you owe or reduces the benefits you get (OAS, GIS, Trillium, HST credits, and just about every other income tested benefit) the incentive for the government to fix this is not there. 

I believe it would be very easy for the government to subtract out this grossed up fake income, when calculating everything else that is income tested, but their reluctance to do so is because of the lost tax revenue and increased benefit costs doing so would create... even though doing so would make these systems fairer when compared to similar income levels of others and their taxes paid and benefits received. They are simply leaving it this way for the sole reason this error is making them or saving them a lot of money.


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## agent99 (Sep 11, 2013)

You need to look at a bigger picture that considers dividend tax credits. You have to have quite high income before dividends are taxed higher than capital gains. This is an old article, but in 2012 it was $81k. (The article discusses this same subject). With income splitting maybe $160k for a couple? As LTR said, at that income level, partial clawback of OAS is not that important and it is built into the overall tax rates.

To get a better hold of this, create two break downs of your expected retirement income. One with investment income from Capital Gains and one with dividends. Enter these in a free 2018 tax program, like Studio Tax and compare results. If you are married, use income splitting. This may give you a better picture of the difference.

One other thing to consider, is that dividends tend to provide a lot more stable cash flow. Selling stocks when markets are down is never fun 

For a quick check, this calculator might help: https://www.taxtips.ca/calculators/basic/basic-tax-calculator.htm. I ran a case where a retiree had $55k in other income (assuming RRSP/RRIF withdrawal, part time job, ??) then either $25k in Capital gains from selling stocks or $25k in dividends, In Ontario, the total tax to be paid would be $1850 less in the dividend's favour.


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## OptsyEagle (Nov 29, 2009)

I should also add that dodging dividends is something that you might be able to do, but replacing them with capital gains is a lot more tricky. Selling before ex div is certainly not the way. That has all kinds of problems that will annoy you.

I will point out that most people compare tax rates on dividends compared to capital gains, with a tremendous amount of error. Most people simply compare the tax on for example a $1,000 of dividends to a $1,000 of capital gains. That is interesting math but it is not suitable to the real world.

*1st*. It is almost impossible to be sure to earn $1,000 of capital gains. You might earn more, you might earn less, you might end up with a loss. It is not something one can ensure will end up on a tax return or in their pocket.

*2nd* We are talking about taxes on income. Income used in retirement. If you have $100,000 invested and it earns $5,000 of dividends, then you now have *$5,000 of dividends to put on your tax return.* We gross up we have a dividend tax credit, etc., etc.
However, if you have $100,000 invested and even if it grows to $105,000, and you sell that extra $5,000 to supplement your retirement, you don't have $5,000 of capital gains to pay tax on. *This is a PRO-RATA disposition. * You only sold $5,000 of a $105,000 portfolio that had an unrealized capital gain of 5%. So your capital gains on that sale was actually 5% x $5,000 = $250 of capital gains, of which only *$125 of it would be taxable capital gains.* Most of the sale was considered your own capital and the tax on the rest of the gain was deferred.

So you can see, that if you can figure out how to earn capital gains only, it is much more tax friendly then most of these so called experts even seem to understand.


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## like_to_retire (Oct 9, 2016)

OptsyEagle said:


> *2nd* We are talking about taxes on income. Income used in retirement. If you have $100,000 invested and it earns $5,000 of dividends, then you now have *$5,000 of dividends to put on your tax return.* We gross up we have a dividend tax credit, etc., etc.
> However, if you have $100,000 invested and even if it grows to $105,000, and you sell that extra $5,000 to supplement your retirement, you don't have $5,000 of capital gains to pay tax on. *This is a PRO-RATA disposition. * You only sold $5,000 of a $105,000 portfolio that had an unrealized capital gain of 5%. So your capital gains on that sale was actually *5% x $5,000 = $250 of capital gains*, of which only *$125 of it would be taxable capital gains.* Most of the sale was considered your own capital and the tax on the rest of the gain was deferred.
> 
> So you can see, that if you can figure out how to earn capital gains only, it is much more tax friendly then most of these so called experts even seem to understand.


Not to nitpick, but the number of shares sold to get the $5000 cash is determined by the *new price* (5% greater than cost base), and the Capital Gain is determined by the Proceeds of Disposition less the Book Value of the Sold Units (determined by the *original price* [cost base] multiplied by the units sold). 

Therefore the math expression (I believe) would be:

(5% x $5000) x (100,000/105,000) = $238.10 capital gain rather than $250 capital gain you calculated.

ltr


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## OptsyEagle (Nov 29, 2009)

That is so close to the same I won't bother double checking your math. I am sure you are right.

Obviously the main point I am making is *the same $5,000 of dividends compared to $5,000 of capital gains*, works out to be the* tax owed on $5,000 of dividends *or *the tax owed on $238 of capital gains*. Quite the difference and I have not even got into the issue of the $1,900 of fictional income the grossing up process does to every other benefit in ones life, when the income is in the form of dividends and not capital gains.

You rarely here the experts talk about that.


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## agent99 (Sep 11, 2013)

OptsyEagle said:


> So your capital gains on that sale was actually 5% x $5,000 = $250 of capital gains, of which only *$125 of it would be taxable capital gains.* Most of the sale was considered your own capital and the tax on the rest of the gain was deferred.


Not surprising that we would not have to pay tax by spending our own money.



> Tax consequences:
> A) results in net taxable income of $13800
> 
> B) results in a capital gain which will only be taxed at 50%. But this is offset by the fact that I can buy the stock back and reset the ACB so the next cap gain will be less.


Dotnet. You lost me there. If you needed to draw $5000 one way or the other, where would the money come from to buy back the stock?


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## My Own Advisor (Sep 24, 2012)

I'm not convinced you have to avoid dividends in a taxable account altogether, to avoid the OAS clawback, rather, be strategic about asset location to support tax efficiency. 

You can always move to an approach whereby you own dividend paying stocks, but they are lower-yielding stocks and pay little dividends but offer more capital growth. Companies like CNR, CAR.UN, MRU with < 4% yield come to mind.


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## OptsyEagle (Nov 29, 2009)

agent99 said:


> Not surprising that we would not have to pay tax by spending our own money.


Sure. I have always said, since the government taxes income and ignores capital, one should strive to shelter their income and spend their capital.

That said, the ability to generate only capital gains is fraught with problems. The biggest one is the inability to confidently achieve them on a regular basis, whereas interest and dividends can be done with a lot more predictability.

With that said, I should lastly add to this thread, that the mutual fund industry tripped on to what I am saying above, a number of years ago. Since they saw how dramatic the tax benefits of deferred capital gains can be, as I have illustrated above, they invented a whole new class of mutual funds to offer this benefit to investors. They are called T-class funds, with the T standing for tax. They are funds that will issue 5% or 8% or some other such percentage of the fund as a monthly distribution. They even figured out how to get rid of that miniscule $238 that LTR and I have been discussing. Since they have the ability to use "return of capital" they promise 0 dollars of taxable income from these monthly distributions. 

Obviously if those funds generate interest, dividends or any realized capital gains from fund activity, then they will be forced to issue a t-slip for that income. So effectively there are 13 distribution per year from a T-class mutual fund, but in the end, their design was to capture the tax benefits of how capital gains are generated compared to how they are actually taxed.


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## agent99 (Sep 11, 2013)

My Own Advisor said:


> You can always move to an approach whereby you own dividend paying stocks, but they are lower-yielding stocks and pay little dividends but offer more capital growth. Companies like CNR, CAR.UN, MRU with < 4% yield come to mind.


Makes sense. I should have a look at that class of shares. I have generally been able to only have limited clawback. This because some shares like REITs paid ROC. But then sometimes they didn't! Mind you, I don't get to excited about the clawback. It's just part of tax system, but just the name has negative connotations.


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## dotnet_nerd (Jul 1, 2009)

agent99 said:


> Dotnet. You lost me there. If you needed to draw $5000 one way or the other, where would the money come from to buy back the stock?


On Rebalancing. I'm using a total-return approach.

Example: Let's say I need to draw $10,000 from my total portfolio to meet my expenses. And I want a 60/40 stock/FI ratio. And, to keep it simple, I have a 6-pack basket of large cap dividend payers.
Stocks are having a good year and I calculate the equity ratio is now 65%

So I need to sell some equities to rebalance. I can choose to do this before or after the ex-div date of one of the stocks I choose to sell.

I'd be better to sell before ex-div.

Where would the money come from to buy back the stock? On the next re-balance, if the ratio falls below 60% the money will be coming from the sale of bonds or the maturity of a GIC etc.


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## Eclectic12 (Oct 20, 2010)

agent99 said:


> Not surprising that we would not have to pay tax by spending our own money ...


Which would make REITs that pays 90+% of their distribution as RoC attractive. It is considered one's own money so it isn't taxable as it is paid and won't increase one's income.

There is an increased future CG tax bill.





agent99 said:


> ... Dotnet. You lost me there. If you needed to draw $5000 one way or the other, where would the money come from to buy back the stock?


Where one needs $5K and only sells enough to cover the $5K plus the sell commission - there won't be anything left to buy back the stock.

Presumably, where one needs $5k something more than that is sold - leaving a remainder to re buy some stock that did not pay the eligible dividend. Way to complicated for me with limited time while working but I'll likely have a lot more time to figure it out when retired. :biggrin:


Cheers


*PS*
There's also the opportunity to concentrate in retirement to make sure as much as possible of the eligible dividends are in a TFSA or two, where one likes the company prospects.


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## AltaRed (Jun 8, 2009)

OptsyEagle said:


> It is quite annoying. The gross up is the governments attempt to ensure that there is little or no double taxation when it comes to corporate income trickling down to the personal level. Great good job. The problem, as you have pointed out, is this gross up of taxable income creates a whole slew of new tax and benefit problems. Since almost all of the problems either increases the tax you owe or reduces the benefits you get (OAS, GIS, Trillium, HST credits, and just about every other income tested benefit) the incentive for the government to fix this is not there.
> 
> I believe it would be very easy for the government to subtract out this grossed up fake income, when calculating everything else that is income tested, but their reluctance to do so is because of the lost tax revenue and increased benefit costs doing so would create... even though doing so would make these systems fairer when compared to similar income levels of others and their taxes paid and benefits received. They are simply leaving it this way for the sole reason this error is making them or saving them a lot of money.


Do you suggest the gov't overhaul the corporate tax system by forcing payment of dividends out of pre-tax income, as per interest? And then we see a higher grossed up amount and pay full personal MTR tax rate on that income?


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## Eclectic12 (Oct 20, 2010)

dotnet_nerd said:


> ... Where would the money come from to buy back the stock? On the next re-balance, if the ratio falls below 60% the money will be coming from the sale of bonds or the maturity of a GIC etc.


If you like the company prospects but don't like the gross up's effect on OAS, should you be re-buying in a registered account as much as possible?
Where it is a taxable account, re-buying is adding back the same issue.


Cheers


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## agent99 (Sep 11, 2013)

dotnet_nerd said:


> On Rebalancing. I'm using a total-return approach.
> 
> Example: Let's say I need to draw $10,000 from my total portfolio to meet my expenses. And I want a 60/40 stock/FI ratio. And, to keep it simple, I have a 6-pack basket of large cap dividend payers.
> Stocks are having a good year and I calculate the equity ratio is now 65%
> ...


Ok, I think I understand - you would rather have a slightly higher capital gain than a lower gain plus a dividend. 

Personally, I don't worry too much about re-balancing. Those 60/40 percentages can be misleading. I start to "think" about allocation if our FI drops below 40%. Most of time, the markets seem to take care of it. In 08/09 our % FI was the highest ever! That's what happens when the markets tank. 

More important, I believe, is to have a certain dollar amount in FI. If the markets tank, that will mostly still be there. Right now, I am trying to trim a few less than stellar stocks and use the money for bonds/gics in registered or pfds in taxable accounts.


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## james4beach (Nov 15, 2012)

dotnet_nerd said:


> Ideally, one could mark ex-div dates on the calendar and dodge dividend payouts.


I think that's a lot of work, and there's going to be inefficiency in doing that. You're going to have trade fees in addition to bid/ask spreads (slippage) and it's going to add up to a lot of hassle, plus some performance loss. In my opinion trading around the ex div dates is not a great option.

I hesitated to post this because I don't think this is a great idea, but it's achievable: you can create a portfolio of low dividend individual stocks. I do it myself, also to avoid dividends and have more capital gain based performance. I've been doing this for over 2 years so far and my performance is slightly higher than XIC, in total return form. My portfolio currently has a dividend yield of 0.6% so it's virtually no dividends, and all capital gains. It's like holding the TSX but converting the dividend component into added price return... I love it.

The basic idea: you look at the TSX Composite, probably at the larger weightings (to avoid the small insignificant constituents) and then choose decent stocks with low dividends. If you choose _enough_ non-awful stocks, with appropriate sector diversification, you will get performance similar to the TSX index. It's bound to happen due to averaging.

This will require portfolio management, regularly monitoring your portfolio, and a methodology. You *must* do these with some routine, otherwise you will stray from the Canadian index and that's not the goal. Managing a portfolio of individual stocks is hard, but doable.

To get you started, here's an example of what I mean:

Pull up the XIC page and look at its holdings, in order of weight. You'd want to run down the list and choose stocks that have lower dividends, from diverse sectors. Some discretion is needed to avoid horrible stocks, and beware of very volatile stocks. Make sure you balance out the sectors well. Pretty easy process:

BAM.A (financial)
CP (industrial)
ATD.B (consumer)
SHOP (tech)
WCN (industrial)
GIB.A (tech)
FFH (financial)
DOL (consumer)
TRI (industrial)
CVE (energy)

So there you go, here's a portfolio of 10 low dividend stocks. The sector weights are 20% financials, 30% industrial, 20% consumer, 20% tech, 10% energy and the dividend yield is only 1.0%

The total return performance of this will be similar to the TSX, but the dividends are just a fraction of the regular index. You will definitely have to monitor and adjust positions over time... that's where this gets difficult... but if you decide on a methodology and stick to it, it's doable.

I do it myself, not with these exact stocks but the same kind of idea. And it's been working for over 2 years. If the idea appeals to you, perhaps open a paper trading or practice account somewhere and try your hand at it for a couple years. See if you're able to manage the portfolio and achieve a return similar to the TSX.


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## dotnet_nerd (Jul 1, 2009)

Thanks James for that detailed explanation. Great strategy, I hope that continues to work well for you.


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## My Own Advisor (Sep 24, 2012)

Exactly what I mentioned upstream, although James provided more details


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## dotnet_nerd (Jul 1, 2009)

My Own Advisor said:


> Exactly what I mentioned upstream, although James provided more details


Yes, and thanks Mark. I didn't get a chance to reply yet. I love your blog btw


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## OptsyEagle (Nov 29, 2009)

AltaRed said:


> Do you suggest the gov't overhaul the corporate tax system by forcing payment of dividends out of pre-tax income, as per interest? And then we see a higher grossed up amount and pay full personal MTR tax rate on that income?


I would leave everything the way it is, but create a new line on the tax return that measures a person's "actual" income, not the grossed up income. Then the various agencies as well as CRA that uses income to determine benefits or tax credits etc., would use that line for their determinations. That line obviously would subtract out the "gross up" of dividends and only be left with a taxpayers "actual" income. I should add, that line would also add back the 50% of capital gains that was received but not taxed.

The reason for this is to make the system fair. Let's face it. That taxpayer that is being discriminated against did not receive that income. When compared to another tax payer that received the same income, but the other person earned it a different way, they both are not taxed the same and they should be. 

This would be an easy fix. Just one extra line on the tax return, but as I said, the only reason for them not to do it, is because if they did it, it would cost the governments significantly more money and/or they would lose a lot of tax revenue. I imagine they figure if you receive a dividend, you must have money and therefore who cares, you're probably rich, fair game for discrimination. 

In my tax world there would be no discrimination, except for discrimination by actual income levels. That's it, that's all, that's the only one that's fair. That said, in my tax world, you could say goodbye to age credits, pension income credits, pension income splitting before age 65, and quite a few other discriminatory and therefore unfair tax credits. So I suppose we have to be careful what we ask for.


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## nortel'd (Mar 20, 2012)

OptsyEagle said:


> It is quite annoying. The gross up is the governments attempt to ensure that there is little or no double taxation when it comes to corporate income trickling down to the personal level. Great good job. The problem, as you have pointed out, is this gross up of taxable income creates a whole slew of new tax and benefit problems. Since almost all of the problems either increases the tax you owe or reduces the benefits you get (OAS, GIS, Trillium, HST credits, and just about every other income tested benefit) the incentive for the government to fix this is not there.
> 
> I believe it would be very easy for the government to subtract out this grossed up fake income, when calculating everything else that is income tested, but their reluctance to do so is because of the lost tax revenue and increased benefit costs doing so would create... even though doing so would make these systems fairer when compared to similar income levels of others and their taxes paid and benefits received. They are simply leaving it this way for the sole reason this error is making them or saving them a lot of money.





AltaRed said:


> Do you suggest the gov't overhaul the corporate tax system by forcing payment of dividends out of pre-tax income, as per interest? And then we see a higher grossed up amount and pay full personal MTR tax rate on that income?



Me thinks ... Income Trust model prior to 2006.


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## james4beach (Nov 15, 2012)

dotnet_nerd said:


> Thanks James for that detailed explanation. Great strategy, I hope that continues to work well for you.


Thanks. Just beware that any time you try using individual stocks instead of the index, there's a lot of work involved and you have to keep managing the portfolio. The individual stocks in the portfolio can swing around a lot and this kind of "low dividend" portfolio is probably going to be more volatile than the index, due to (a) the small cap stocks and (b) limited diversification of a handful of stocks.

Here's an example: my individual stock portfolio held GOOS which, it turns out, is an insanely volatile stock. For example it's down 23% today. Luckily (and this is just partially luck) I spotted its weakness a couple months ago and got rid of the stock. But this is a good example of how the small or mid cap stocks that make up a low dividend portfolio can be very volatile, causing some wild movements.


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## OptsyEagle (Nov 29, 2009)

Also, the idea that the income will almost always be paid out from selling the fixed income (not the stocks) when rebalancing, during bad years in the stock market, will happen more often as the percentage of fixed income in the portfolio increases.

We have seen that 60:40 stocks to bonds works well. We know 100:0 stocks to bonds will be a disaster. What we don't know is what happens to all the combinations in between. For example, what would happen to the portfolios, over the same time frame, that were weighted 75:25 stocks to bonds. 

I assume the more stocks you have would increase the sequence of return risk accordingly. All we know for now, from this analysis, is that 60:40 seems to work well, thanks to the work J4B has done.


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