Dividend or income investors, here are the fundamental facts on how to save tax.

Would you like to receive dividends of any amount you want from your non-registered investments, and pay less tax than on ordinary dividends? You can easily do this with a little planning and proper understanding of investments.

Self-made dividends are a simple concept with profound benefits. Dividend investing has been very popular recently, but self-made dividends are better than ordinary dividends in essentially every way. They have lower taxes, better investment options, and are much more flexible for giving you income when you need it.

When clients retire and I setup the retirement income they want, self-made dividends make the process easy and usually save a lot of tax.

Self-made dividends are a perfect fit for a retirement plan. They fit your life.


What are self-made dividends?

Self-made dividends are simply a strategy to sell some of your investments each month. This can be automated with mutual funds or segregated funds, and is called a “SWP” (systematic withdrawal plan). With other investments, just sell investments to give you the cash flow you need.

You decide how much you want to sell every year. It is advisable, though, that you withdraw an amount that is sustainable long term.

When you sell an investment, you pay tax on the capital gain, to the extent that your investment has gone up. Unless you have owned an investment many years and it is up a lot, the portion that is taxable is low.


How do self-made dividends work in a retirement plan?

Depending on how you invest, withdrawing between 3% to 5% of your investments per year is generally considered sustainable long term. In my own research, I found that withdrawing 4% per year from an equity portfolio and increasing it by inflation provided a reliable retirement income virtually 100% of the time in the last 150 years. For a more conservative portfolio that includes bonds, 3% per year is a better choice.

Let’s say you have $1 million in investments. You consider 4% per year as a sustainable withdrawal, so you withdraw $40,000 from your investments every year.

You can increase or decrease this any time you want. It is completely flexible.

Now let’s say you accumulated the $1 million by investing $500,000 over the years. Your investments have doubled. *

When you sell $40,000 for this year’s retirement income, only the half that is the gain is a capital gain, which means you have a $20,000 capital gain. Only 50% of capital gains are taxable, so you have a $10,000 taxable capital gain.

If you had received an ordinary dividend, the entire $40,000 would be taxable. But since you have a self-made dividend (sold $40,000 of your investments), only $10,000 is taxable.

In your retirement plan, it is actually cash flow that you need, not income. Income is taxable. Cash flow is sometimes taxable and sometimes not. Self-made dividends give you the cash flow you want in your retirement, while having only a small portion of it be considered taxable income.

While you are saving for retirement, normally you should choose a zero self-made dividend until you need the cash. Why pay tax on a withdrawal you don’t need? Then when you retire, flip the switch and turn on your self-made dividend the day you want the cash. Choose any amount, but 3-5%/year should be sustainable long term, depending on how you invest.


What is the big picture?

Dividend investing is part of the “search for yield” of many investors today. Interest rates are too low to grow wealth. Equity investors are fearful ever since the crash in 2008, so they want dividends now instead of waiting for growth.

The search for yield has made stocks with high dividends very expensive, even though most of these stocks have little or no growth, or are even shrinking. It has created a “dividend bubble”.  Just like the technology bubble in the 1990s, dividend investors seem to think valuation does not matter.

If you are investing in expensive companies with low growth, you should assume a risk of a major downturn and a low return long term. What will happen to dividend stocks whenever interest rates rise?

Dividend investors often end up with very poor diversification for several reasons:

  1. They often invest entirely or mainly in Canada, since tax on Canadian dividends are taxed at lower rates. Canada is only 3% of the world’s stock market and most of the world is growing faster.
  2. They often heavily over-weight the sectors that have the highest dividend rates, such as utilities, telecom, consumer staples, energy & financials. There are many other sectors, most of which have faster growth.

Self-made dividends avoid all these risks.

Self-made dividend investors can invest properly based on risk/return, quality and diversification. Of course, most companies in the stock market pay dividends, so any diversified portfolio probably has stocks that pay dividends. However, the dividend rate does not drive the investment bus.


Why are self-made dividends better than ordinary dividends?

Self-made dividends are taxed at lower rates. In addition, dividends have 2 big risks – over-valuation and lack of diversification. Self-made dividends avoid these risks and have a list of major advantages:

  1. You decide the amount of dividend you receive.
  2. You can start, stop and change the dividend any time you want.
  3. You are not forced to pay tax on dividends when you don’t need the cash.
  4. You can invest properly based on risk/return, instead of chasing yield.
  5. You can avoid buying expensive investments to get a higher dividend.
  6. You can properly diversify globally, instead of having all your investments in Canada.
  7. For seniors, the clawback of government benefits from ordinary dividends is 5-6 higher than on self-made dividends.
  8. You pay less tax than on ordinary dividends (or sometimes no tax):

Self-made dividends are essentially taxed as deferred capital gains, which are the lowest taxed form of investment income. This article explains it: .

Tax on self-made dividends start at zero. When you sell a bit of an investment you just bought, there is no gain yet, so the entire self-made dividend is tax-free.

The tax rate normally rises to about half the capital gains tax rate after about 10 years (when your investments have doubled) and about 2/3 the capital gains tax rate after 15-20 years (when your investments have tripled). * They may get close to the capital gains tax rate after 30-50 years.

Here are the tax rates:


Ordinary dividends are a disaster for seniors!

For seniors, ordinary dividends can be a disaster! Many government benefits are clawed back based on income. Ordinary dividends are “grossed-up” on your tax return by 38%, so 138% of the dividend is considered income. All clawbacks apply to 138% of the dividend.

For example, the GIS program for seniors is clawed back at 50% of your income. For dividends, the taxable income is 138% of the dividend, and 50% of that is clawed back. Dividend investors have a 69% clawback on top of income tax!

In addition, many government benefits and subsidies for seniors are income-tested. The annual deductible on drugs, rent in many retirement buildings and many government benefits are all income tested. In every case, the income test applies to 138% of the dividend. It is not uncommon for low income seniors to pay more than 100% of their dividend between clawbacks, lost benefits and income tax.

For self-made dividend investors, between 0% and 50% of the self-made dividend is considered income, so the 50% GIS clawback is only 0%-25%. Typically, the clawback is about 12% (assuming your investments have doubled over the years).

In short, many seniors should avoid dividend investing after age 65. The taxable income used by income-tested clawbacks is typically about 25% of self-made dividends, but 138% of ordinary dividends. Ordinary dividends can be a disaster for seniors!


Are you taking principal, while ordinary dividends are income?

Rainfall and snowfall are both precipitation. Similarly, capital gains and dividends are both part of the total return on your investment.

With equity investments, there is no such thing as “principal”. The valid factor is “net invested” – cash invested less cash withdrawn. Whether you receive self-made dividends or ordinary dividends, you are withdrawing cash from your investment.

This requires some background knowledge on stocks. Companies can do 4 things with their profits – reinvest in the business, buy other companies, buy back their own shares, or pay dividends. If companies did not pay dividends, they could grow their company faster by reinvesting. Many companies are doing share buy-backs instead of paying dividends today. This is more tax-efficient than paying a dividend and means investors own a larger portion of the company. All 4 uses of cash contribute to total return.

Smart investors never pay extra for dividends on their investments. Warren Buffett says investors should be “agnostic about dividends”.

Ordinary dividends have no magic.



In short, self-made dividends are better than ordinary dividends in essentially every way. Dividends have 2 big risks – over-valuation and lack of diversification. Self-made dividends avoid both risks and have a list of major advantages, especially lower tax, better investment options and complete flexibility.

Self-made dividends are a perfect fit for a retirement plan. They fit your life.






* In most cases, the “book value” of your investments would be higher than $500,000, because the book value changes every time you buy and sell investments, and because the book value includes reinvested dividends or capital gains distributions. Therefore, the portion of the $40,000 self-made dividend that is taxable would be less than $10,000.

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