Many people don’t realize it, but dividend increases are actually similar to annual raises – they reward good performance, they are meant to fight inflation and they put more money in your pocket.
Related: 5 Advantages of Dividend Stocks
Here are a few reasons why dividend increases are even better than annual raises.
Dividend Increases Fight Inflation
When a company gives employees an annual raise, it is based on market conditions and current budgets within the company. There is no guarantee the raises will continue during a downturn in the economy or if the company hits turmoil. If something negative happens with that company, all employees could be affected.
Annual dividend increases help fight inflation as well – and can be safer than relying on an annual raise from an employer. A well-balanced portfolio of stocks that have a history of increasing their annual dividends can be a safer bet (in some cases). Since the portfolio contains numerous companies in a variety of industries, the risk doesn’t lie with the finances of one company – it’s spread out over several of them.
As an example – while many companies were laying off employees during the economic downturn of 2008-09, Canada’s biggest 5 banks all maintained their dividend payments. No company is immune to an economic downturn, but holding dividend stocks helps spread the risks over multiple companies rather than relying on one company for a raise.
Dividends are Taxed More Favorably
Dividend increases are better than annual raises because dividend income is taxed more favorably than employment income.
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When an employee earns employment income, it gets taxed at his/her marginal tax rate. When an investor earns dividend income from publicly-traded Canadian companies, the income is given a tax credit – the government’s way of encouraging us to invest in Canadian companies.
For example: using 2013 tax rates, if a resident of Ontario had $50,000 employment income they would have a marginal tax rate of 31%. If the same person had $50,000 of dividends they would have a marginal tax rate of 13% – a huge difference when considering the number of years a retiree can live off dividend income. Bottom line: dividend income from Canadian public companies is taxed favorably.
While it’s true that dividends from publicly-traded Canadian companies are “grossed-up” and can cut into benefits like Old Age Security – Jamie Golombek, managing director with CIBC Wealth Advisory Services, has stated that only 3% of retirees are affected by this.
Capital Remains Untouched
The nice thing about dividend income is that it can provide steady monthly income while the stocks themselves remain untouched.
Dividend income allows an investor to maintain their investments and make the decision when to sell when it is best for them. This is especially useful for a retiree who needs the dividend income to pay for monthly expenses but isn’t ready to sell their shares yet.
With annual raises, there is no capital owned by the employee (aside from company shares). When an employee gets a raise, it’s not related to a tangible asset that he/she can control.
Conclusion: if you didn’t get an annual raise this year (or even if you did), consider investing in dividend stocks that have a tendency to increase their dividends over time. Dividends fight inflation, are taxed more favorably and the capital (shares) remain untouched while you collect dividend income. Not too bad!
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