Make more money; pay less tax

A Conversation with John 

John*, a prospective client, was in my office and we were having a preliminary chat. “Last year I had to pay an extra $10,000 in taxes! Is there something you could do about that?” John asked.

“I’m not sure. I see that you’ve brought in your tax returns. Mind if I take a look at them?” I replied.

Within minutes of reviewing his returns, I could see what had happened. The additional tax was due to $30,000 of earned interest that only showed up in the previous year’s return. 

“Tell me about this $30K in interest you earned in the last year. What’s that about?” I asked.

“Well, I inherited about three-quarters of a million dollars at the beginning of that year and, being unsure of what to do, I deposited it in a two-year GIC at TD Bank earning 4 percent,” he responded. 

“OK. That makes sense,” I responded. “Here’s the deal. At your income level and since we’re in BC, you pay a combined 32.79% of tax on every extra dollar you earn. So that $30,000 in interest resulted in an additional tax burden of about $9,837,” I explained. 

“But I didn’t get the money,” he retorted. “I mean, I can see that my account has grown. That it’s been added to the value of the GIC. But I can’t even cash out the GIC yet!” John despaired. “It’s still stuck there for another year, and now I’m wishing I could just pull it out.”  

Commiserating, I explained, “Yeah, I get that. It’s frustrating. But the CRA looks at what you’ve earned for the year, not what you’ve collected. That’s the case when it comes to any interest earned, which includes GICs. Even worse, they tax interest just like regular income. Frankly, there is nothing we can do until your GIC matures. But when it does, we have options. I’d like to share one of my favourites with you. How would you feel about making more money and paying less tax at the same time?” 

Dubious, he replied, “I like the sound of that, but how is that even possible?”

“Well, for now, let’s just assume that you could be comfortable owning a bunch of really big companies in Canada. Companies with valuations that aren’t guaranteed, but that fairly consistently earn more money each year and pretty consistently increase their dividend to their owners each and every year. So, let’s say we go that way, and since company valuations are generally highly correlated to their profits, I would say it’s highly likely that you would receive a higher income each year and pay less tax each year. And if you hang on to them over a five-year period, it’s highly likely that you will also be able to sell them for more than you paid for them.”

John was curious, but still somewhat skeptical. “I don’t know about that. Can you give me an example?” 

“Well, I’m talking about a basket of companies, not just one, so in the very unlikely event that one of the companies blows up, it won’t be catastrophic. But let’s just look at one of the companies as an example for you. Let’s look at TD Bank, since that’s where you have the existing GIC deposited. I’m not at all saying this should be your go-to investment, but let’s just use it as an example since that’s where you started. Let’s say you put all $750K of your inheritance into the one company. Again, don’t really do that. That’s not diverse enough. But let’s just assume you did, and it worked out.

“Currently, TD Bank shares sell at $76.97 per share.** They earn about $5.95 per share and pay $4.08 of the profits out for a dividend of 5.30 percent. On your $750K, you would be able to buy 9,744 shares and be paid a quarterly dividend that amounted to $39,750. So, first off you are earning more. Almost $10K more than the $30K from your current GIC.”

“OK, that’s making sense so far,” said John, nodding. 

“But it doesn’t stop there. At all income levels, dividends and capital gains are taxed more preferably than interest or salary. At your income level specifically, a dividend will only be taxed at a rate of 7.96%. So instead of paying $10,000 in tax you could pay less than a third of that. A 7.96 percent tax on $39,750 is just $3,164.

“So instead of earning $30,000, you could have earned $39,750. And instead of paying $9,837 in taxes, it could have been just $3,164. At the end of the day, after returns and taxes were considered, you would have been ahead by a whopping total of $16,423. Admittedly, this scenario ignores some factors. You probably wouldn’t go out and do that on your own, so you would probably have to pay some fees for somebody to manage it for you. But if you’re going to do that, then you should probably also consider that a manager likely wouldn’t buy a company unless they also thought it would go up in value at least a bit and that they would always be on the lookout for the best deals. So, let’s say you end up paying 2 percent in fees and that the increase in value is also 2 percent. They would just wash each other out. You’d be ahead a bit in this scenario because the gains are also tax-preferred, so you could immediately and fully write off the fees, but that gets complicated, so let’s just leave it as a wash. I just don’t want to leave you with the impression that the money management comes free.”

“I appreciate that,” said John. 

“If you think that TD is likely to be making more money five years from today, then it’s a good bet that the company will be worth more five years from today. The result being that you could sell your shares at that time for more than you paid for them. In the meantime, you would have been collecting a dividend earning worth more than the interest on your GIC, and you’d be paying much less tax. A win on both fronts for you. Oh, and something I didn’t factor in is that TD has increased their dividend almost every year, so by the time the five years is up, you will likely be receiving an even higher income stream than you started with.

“Like I said at the beginning: make more money; pay less tax.”

John’s GIC won’t mature for 12 more months, but at that time he is sure to make some changes. If you are sitting on large piles of cash or GIC balances, you should do the same. 

Obviously, the percentages will change depending on your actual income and province of residence, but the principle holds true: dividends and capital gains are superior in almost every situation. Don’t let a GIC be your default. They are usually one of the worst choices someone can make.

“Refuse good advice and watch your plans fail;
    take good counsel and watch them succeed.”

• Proverbs 15:22 (The Message)

* Name has been changed to protect identity. 

**This article was originally written on May 27, 2024. Share price and dividend references are accurate as of that date and may not be the same at time of reading.

Arnold Machel lives, works, and worships in the White Rock/South Surrey area. He holds the Certified Financial Planner® designation, is the Founder of Visionvest Financial Planning & Services, and sits on the board of Abundance Canada. Visionvest (his firm) has been voted Best Investment/Financial Advisor by Peace Arch News readers for the past three years in a row.

Questions and comments can be directed to him at dr.rrsp@visionvest.ca. Please note that all comments are of a general nature and should not be relied upon as individual advice. While every attempt is made to ensure accuracy, facts and figures are not guaranteed.