A guide to dividend investing in Canada

This is the overview. Each section links to a longer piece on the same subject, so read it straight through and follow whatever you want more of.

Where the money comes from

A company that makes more than it needs can reinvest it, buy back shares, or pay it out. The third is a dividend.

That framing matters, because it means a dividend is not a bonus. It is a decision to hand capital back rather than deploy it — reasonable for a mature bank or utility with limited expansion runway, and a warning sign in a company that should be reinvesting.

The Canadian market is unusually concentrated in exactly the businesses that fit the first description: banks, insurers, pipelines, utilities, telecoms, railways. That is why Canadian portfolios lean toward income more than most, and why the TSX is a genuinely good place to do this.

Funds — ETFs and mutual funds — hold baskets of these and pass through what they receive, minus a fee. Most Canadian income ETFs are structured as trusts, which is why you get a T3 slip rather than a T5, and why it arrives later.

What you can realistically earn

Broad Canadian dividend funds sit in the low-to-mid single digits. Individual blue-chip payers are similar. Covered call and structured products advertise considerably more.

The rule that survives contact with reality: yield and safety of the payment trade against each other. Nothing on a screener is mispriced by 6 percentage points because nobody noticed.

More useful than yield is total return — distributions plus price change. A 12% yield with the unit price falling 8% a year returned 4%, and handed you a tax bill along the way. A 4% yield with the price up 5% returned 9%. Yield describes a payment. Total return describes what happened to your money.

Why the highest yield is rarely the best

A high yield arises two ways: the payment went up, or the price went down. The second is far more common, and a falling price is often the market pricing in a cut that has not been announced.

Things worth checking before yield:

• Is the payment covered by what the business or fund actually earns?
• What is the payment made of? Eligible dividends, capital gains, foreign income, and return of capital are four different things with four different tax treatments.
• Has it been raised? A record of increases says more than the current level.
• What is the all-in fee, including any fund held inside the fund?

The formula takes a headline yield apart into those pieces.

Not all income is taxed the same

This is where Canada differs most from what you will read on American sites.

Eligible dividends from Canadian corporations are grossed up 38% and then credited back, federally and provincially. The effect is that they are the most lightly taxed income available in a non-registered account — at lower income levels, in some provinces, at a negative effective rate.

Foreign dividends get none of this and are taxed like interest, at your full marginal rate. Return of capital is not taxed on receipt but lowers your cost base, deferring the bill to the year you sell. Capital gains are half-taxable.

Full detail: how dividends are taxed in Canada. Combined rates for every province: the tax tables.

Which account to keep it in

The clearest rules in Canadian investing, and they are worth following even when everything else is guesswork:

• US-domiciled payers belong in an RRSP. The Canada–US treaty waives the 15% withholding there and nowhere else. In a TFSA it is lost permanently.
• Eligible Canadian dividends work hardest in a non-registered account, because the dividend tax credit only offsets tax you would otherwise owe.
• Interest and foreign income benefit most from a shelter, because they are taxed the hardest outside one.

More: TFSA vs RRSP for dividends.

How the high payers pay so much

Most Canadian funds yielding well into double digits are covered call funds. They sell away their upside for cash premiums, which funds the distribution.

That is a real trade with a real cost, not a free lunch — you keep the full downside and cap the gains. It suits someone spending the income and suits a flat market. It suits an accumulator in a rising market poorly. See what is a covered call ETF.

Should you borrow to do this?

Occasionally defensible, usually not, and never on the arithmetic people run. Interest is deductible when you borrow to invest in a taxable account and not deductible for a TFSA or RRSP, which removes most of the apparent advantage before you begin. The full argument, and a calculator.

If you take four things

1. Total return, not yield.
2. Account placement is decidable and worth deciding — US payers in the RRSP.
3. Return of capital defers tax, it does not cancel it, and it silently lowers your cost base.
4. A payment that has been raised for twenty years tells you more than one that is high today.