Investing at Retirement: Cash Flow vs. Income

Articles Investing at Retirement: Cash Flow vs. Income

Baby boomers are retiring and interest rates are low. How are they going to generate retirement income from their investments? Most new mutual fund products in the past couple of years have been dividend funds, both Canadian & global. Why is this?

  • Dividend stocks have generated exceptional growth over the past 10 years, while the interest rates have been low
  • Interest income is taxed at the individual’s highest marginal rate
  • Dividends are taxed at less than that
  • Capital gains are taxed at half of the individual’s highest marginal rate
  • The above is true of non-registered investment income
  • In registered plans, tax is not a factor until the money is withdrawn so you just want to increase the value of the plan as much as possible

Dividend income from non-Canadian companies is taxed like interest income, at the individual’s highest marginal rate. What is someone really looking for – income or cash flow? Are they the same thing? How do you maximize your after tax cash flow?

A GIC of $200,000 paying 5% will pay out $10,000 of interest per year.

Similarly a stock with a 5% dividend yield valued at $200,000 will distribute dividends of $10,000 per year.

What about a stock that is growing by 5% per year but not paying dividends? If you sell $10,000 of it per year you get a capital gain.

  • Year One: $10,000 withdrawal that includes a capital gain of $476 or taxable capital gain of $238
  • Year Two: $10,000 withdrawal including a capital gain of $930 or taxable capital gain of $465
  • Year Three: $10,000 withdrawal including a capital gain of $1360 or taxable capital gain of $680
  • Year Four: $10,000 withdrawal including a capital gain of $1773 or taxable capital gain of $886
  • Year Five: $10,000 withdrawal including a capital gain of $2165 or taxable capital gain of $1082

Example: A senior receiving:

OAS of $6,579
CPP of $12,000
Pension income of $55,000

OAS Clawback of $394
Other taxes of $16,250
Net after tax income = $56,936

But they have investments that they can withdraw from. How much will $10,000 from the investments improve their financial situation?

If the $10,000 is interest income or in non-Canadian dividends, then: OAS is clawed back $1,894 and additional taxes are $19,267 resulting in after tax income of $62,419. Therefore the, $10,000 interest was taxed at 45.1%.

If the $10,000 is dividend income: then OAS is clawed back $2,269 and additional taxes are $17,676 resulting in after tax income of $63,634. Therefore the $10,000 dividends were taxed at 33%.

If the $10,000 is all capital gains: then OAS is clawed back $1,144 and additional taxes are $17,747 resulting in after tax income of $64,688. Therefore the $10,000 capital gains were taxed at 22.5%.

If the $10,000 is $8,000 principle and $2,000 capital gains, then: OAS is clawed back $544 and additional taxes are $16,549. Therefore the $10,000 was taxed at 4.5%.

To learn more about retirement income and investments, please contact us at DFS Private Wealth to speak with an advisor.