[CAN] Dividends question

[Freedomin5]

Hoping to pick the collective brain of a bunch of wise people here...

A bit of background: We are Canadians working overseas and cannot contribute to RRSPs and TFSAs. We also likely will not qualify for CPP.

For the past five years, we have used Canadian Couch Potato's ETF model portfolio to structure our investments, which have all gone into a taxable investment account, focusing on growth. We are considering FIRE-ing in 2 to 3 years, and in order to build up a relatively stable passive income stream, I am considering increasing our dividend income. We'd like to reach $20K per year in dividend income (we are currently at $8K a year) -- income that we won't actually need until after we return to Canada. Our current portfolio of index ETFs (VCN, VAB, VXC) throw off a yield of between 1.3% to 3.5%.

Traditionally, the Canadian equity index funds have been heavy on Canadian bank stocks (we only have 5 major banks and they're big players in our economy), which is what contributes to the index ETFs dividend yields. Canadian banks tend to be very stable.  The dividend yield on bank stocks over the past five years is around 5%.

I'm now considering using part of our income over the next few years to purchase individual bank stocks of the five banks to increase our dividend yield while saving on the MER. Another idea is to continue contributing to VCN/VXC according to our current asset allocation, wait until the last year before repatriation -- the repatriation decision is typically made 6 to 8 months before the repatriation date -- and then throw all of our income in the last 6 to 8 months into purchasing bank stocks so that we can speed up the dividend train.

My questions are:

• Does it make sense to purchase individual bank stocks given our goal of dividend income? (breaking from the general wisdom of index funds ONLY)
• Does it make sense to start funneling our income now (3 years before repatriation) into purchasing bank stocks given that it will start to generate dividend income (and taxes?) that we won't need for the next 3 years?
• Or should we wait until close to repatriation or after repatriation to sell off some index ETFs and buy higher dividend-producing funds?
• Is there anything that I'm missing or haven't considered?

I have an idea of what the best option might be, but I want to make sure I haven't missed something. Thank you!

[FLBiker]

Posting more or less to follow.  I'm a US citizen and new Canadian permanent resident (who also, coincidentally, lived in China).

At this point, we've still got all of our holdings in USD (with the taxable stuff now at Questrade).  And we haven't done anything to target dividends in particular, but I'm curious to see what other folks say around that.

[c-kat]

We have done this with our non-registered account. Our RRSPS and TFSAs are all in indexes but we went with 10 individual dividend stocks in our non-registered to take advantage of the dividend tax credit.

If you go the individual stock route I would diversify beyond banks.  For example Canadian utilities have high dividends too. Enbridge pays about 7.5%.  Check out John Heinzl's dividend portfolio in the globe and mail. Also, important to pick dividend growers. There are lots of stocks that increase their dividends by 7 percent plus per year which allows you to grow your income over time. 

Make sure the companies you buy are good. A really high dividend can be a red flag as it could mean something is wrong with the company.  I'd choose a few banks, utilities and choose a few from some other sectors as well.

You can also add a dividend ETF like CDZ to supplement.

[Freedomin5]

We have done this with our non-registered account. Our RRSPS and TFSAs are all in indexes but we went with 10 individual dividend stocks in our non-registered to take advantage of the dividend tax credit.

If you go the individual stock route I would diversify beyond banks.  For example Canadian utilities have high dividends too. Enbridge pays about 7.5%.  Check out John Heinzl's dividend portfolio in the globe and mail. Also, important to pick dividend growers. There are lots of stocks that increase their dividends by 7 percent plus per year which allows you to grow your income over time. 

Make sure the companies you buy are good. A really high dividend can be a red flag as it could mean something is wrong with the company.  I'd choose a few banks, utilities and choose a few from some other sectors as well.

You can also add a dividend ETF like CDZ to supplement.

Thanks for the recommendations. I’ll take a look at the energy companies and dividend ETFs. One of my concerns is making our portfolio too complicated. We are not investing gurus and want to keep things as simple as possible.

[daverobev]

If you're investing unreg, remember there is a 25% withholding tax on Canadian divis for non residents (depending on double taxation agreements, but I don't think Canada reduces theirs?).

Edit - more likely to be 15% because of plenty of DTAs I guess, so less of an issue, can usually be claimed against tax in the foreign country. https://www.clearstream.com/clearstream-en/products-and-services/market-coverage/americas/canada/double-taxation-treaty-countries-and-rates-canada-1282436

For some reason I had it in my head that it was 25% and generally not reduced, so I've been somewhat avoiding Cdn divis for that reason, but if it is generally 15 it is normal.

[Freedomin5]

If you're investing unreg, remember there is a 25% withholding tax on Canadian divis for non residents (depending on double taxation agreements, but I don't think Canada reduces theirs?).

Edit - more likely to be 15% because of plenty of DTAs I guess, so less of an issue, can usually be claimed against tax in the foreign country. https://www.clearstream.com/clearstream-en/products-and-services/market-coverage/americas/canada/double-taxation-treaty-countries-and-rates-canada-1282436

For some reason I had it in my head that it was 25% and generally not reduced, so I've been somewhat avoiding Cdn divis for that reason, but if it is generally 15 it is normal.

Good point. Yes, it's 25%. We're with TD Direct, and they automatically take it off the top whenever they distribute dividends. It's one of the reasons why I'm hesitant to go all out on dividend funds right now when we don't actually need the dividend money. With our capital gains, the taxes are deferred until we sell.

[Freedomin5]

I did a bit of reading, and Canadian Couch Potato has a few articles about the topic. I'm posting here as a way to gather all my info in one place.

Why using dividend ETFs may not be the best idea
I agree with the idea of generating cashflow rather than income. Dividend ETF MERs range up to 0.5%. On a 100K portfolio, that's $500 a year (and our portfolio will likely be larger than that). For $500 a year, I'm fairly confident I can mimic the top funds held in one of the ETFs and invest in the major banks and a couple big energy companies.

A Better Way to Generate Income
While I agree with the general principles, a quick search of the current GIC returns show that they are returning approximately 0.5% for a 1-year GIC, and a measly 1% for a 5-year GIC. That doesn't even keep up with inflation. I don't think a GIC ladder is the best choice in our current environment. Bond returns are also rather lackluster at the moment.

Takeaway 1:
It looks like it's better for me to wait until we need to dividend income to purchase dividend-producing assets, to minimize being unnecessarily taxed on money we do not need.

Takeaway 2:
Since we plan to be low-income (under $50K/year household income), so another consideration is whether dividends or capital gains are taxed more favorably for low-income folks?