Good Morning Everyone. Hopefully you all had a great weekend. Today we are continuing on with another post in our “Investing: The Ins and Outs of Dividends” series. So far we have discussed some helpful investment strategies for the New Year and we have also discussed why you should consider investing in Dividends. Today we are discussing what Dividends are all about. Today we are going to discuss all of the benefits of investing in Dividends including the tax benefits. Before we should invest in anything we should definitely understand what it’s all about. The easiest way to understand Dividends is to know how they compare to other types of Investment Income such as Interest and Capital Gains.
What are Dividends
Investment Income aka the profit gains that we make on our investments can be paid out to investors in one of three formats; Interest, Dividends, and/or Capital Gains. Interest Income is usually paid from Term Deposits, Guaranteed Investment Certificates, Money Market Investments, and Bonds. Interest is earned from lower risk investments and it is taxable at 100% just as if it was income earned from our employment. If we earn $100 in Interest Income then we are taxed on the entire $100.
Dividends are usually earned from investing in stocks of companies that choose to pay out their Dividends to stockholders, usually on a quarterly basis. Dividends are a portion of the company’s profits that are paid out instead of being retained by the company. Dividends can be paid out in cash to shareholders or they can be reinvested in the investment account to purchase more share units.
Dividends are a great way to earn Investment Income because they have tax benefits that Interest Income does not have. There is a dividend tax credit given to all investors who declare dividends as investment income. Therefore investing in Dividends can help us save money because Dividends are not 100% taxable like Interest Income. This tax credit combined with the security of investing in the stocks of large companies that pay out their profits makes dividend investing a very attractive investment option.
Capital Gains are the third type of Investment Income. Capital Gains come from the most risky types of investments. There are two different ways that investors have to declare Capital Gains as Investment Income. The first way that we have to declare Capital Gains is when we sell our investments. We have to declare the difference between the purchase price of our stock units and the price at which we sold them. If we purchased our stock at $10 per unit and we sold it at $15 per unit, the difference of $5 per unit is our Capital Gain.
The second way that investors have to declare Capital Gains is when a company pays out Capital Gain profits to their shareholders. Capital Gains are usually paid out once a year by companies. Capital Gains come from investing in Stocks whose unit price increases. Capital Gains are the most tax efficient type of Investment Income because only 50% of our profits are taxable. Therefore if we earn $100 in Capital Gains we are only taxed on $50.
Even though Capital Gains are the most tax efficient type of Investment Income we have to keep in mind that the risks of investing in options that pay out Capital Gains are higher than the risks of investing in investment options that pay out Interest Income or Dividends.
Check Out the other posts in our “Investing: The Ins and Outs of Dividends” series:
Photo by Adam B