Dividend investing: pros, cons and the dividend tax credit

Topic: Investing Deep Dive · Part 6 of 8 · ⚫ Expert

In one sentence

Dividend investing means choosing investments for the cash they pay out; Canadian dividends get a special tax credit, but they are not free money and they are not always the best plan.

Words to know

Dividend: cash a company pays its owners (shareholders) from its profits.
Eligible dividend: a dividend that most large Canadian public companies pay. It gets the bigger tax credit.
Gross-up: a step where you add extra to the dividend on your tax return before the credit is applied.
Dividend tax credit: a credit that lowers your tax on Canadian dividends.
Total return: all of your gain: dividends plus the rise or fall in price.

Step 1: Understand the gross-up and the credit

A company has already paid corporate tax on its profits. The gross-up and the credit try to give you credit for that tax, so the same money is not fully taxed twice.

For eligible dividends:

Take the cash dividend. Multiply by 138%. This is the “taxable amount” on your return. (The gross-up is 38%.)
Calculate tax on that taxable amount at your normal rate.
Subtract the federal dividend tax credit: 15.0198% of the taxable amount. Your province or territory also gives its own credit.

For other-than-eligible dividends (often from small private companies), the gross-up is 15% and the federal credit is 9.0301% of the taxable amount.

Your T5 or T3 slip usually shows the taxable amount and the credit for you. The credit only applies to Canadian dividends. U.S. and other foreign dividends do not get it. Checked October 2026 on canada.ca.

Inside a TFSA or RRSP, none of this applies. There is no gross-up and no credit there.

Step 2: Know that dividends are not free money

When a company pays a dividend, that cash leaves the company. On the day the stock starts trading without the dividend (the ex-dividend date), the price usually drops by about the same amount.

So a $1 dividend is not a $1 gift. It is part of your total return, paid as cash instead of as a higher price.

Step 3: Weigh the pros and cons

Possible pros:

Regular cash income, which some retirees like.
Lower tax on Canadian eligible dividends than on interest, in a non-registered account.
Many people find it easier to stay invested when they see cash coming in.

Possible cons compared with total-return index investing:

Less diversification. Canadian dividend portfolios often lean heavily on banks, energy, pipelines, telecoms and utilities.
Taxes every year in a non-registered account, even if you do not need the cash.
The grossed-up amount raises your net income, which can reduce income-tested benefits (see Step 5).
A total-return investor can sell a few units when they need cash. The result can be similar, with more diversification.

Step 4: Avoid dividend traps

A dividend trap is a stock with a very high yield that looks attractive, but the dividend is in danger.

High yield after a price drop: if the price fell sharply, the yield goes up. The market may expect a dividend cut.
Payout ratio over 100%: the company pays more in dividends than it earns. That cannot last forever.
Rising debt to keep paying: borrowing to pay dividends is a warning sign.
Chasing yield alone: a dividend cut often comes with a price drop, so you lose twice.

Step 5: Watch the OAS clawback

If you are 65 or older and get Old Age Security (OAS), you may have to repay part of it if your net income is above a threshold. For the 2026 income year, the threshold is $95,323. You repay 15% of your net income above it. Check the current amount on canada.ca.

The OAS clawback uses your grossed-up dividends. So $10,000 of eligible dividends adds $13,800 to your net income. A $10,000 capital gain adds only $5,000.

Example

You receive $1,000 in a non-registered account. To keep the numbers round, imagine a 20% federal tax rate. Real rates depend on your income, and provincial tax is extra.

$1,000 eligible Canadian dividend: taxable amount $1,000 × 1.38 = $1,380. Tax before credit: $1,380 × 20% = $276. Federal credit: $1,380 × 15.0198% ≈ $207.27. Federal tax: $276 − $207.27 = $68.73.
$1,000 interest: $1,000 × 20% = $200.
$1,000 capital gain: taxable half $500 × 20% = $100.

The dividend has the lowest federal tax in this example. But it adds $1,380 to your net income, the most of the three. That matters for the OAS clawback and other income-tested benefits.

Common mistakes

Thinking a dividend is extra money on top of the price change.
Buying the highest-yield stock without checking why the yield is high.
Holding only a few Canadian dividend stocks and calling it diversified.
Forgetting that grossed-up dividends can raise your OAS repayment.

✅ My checklist

☐ I know eligible dividends are grossed up by 38% and get a federal credit of 15.0198%.
☐ I know the dividend tax credit is only for Canadian dividends in a non-registered account.
☐ I look at total return, not only the yield.
☐ I check the payout ratio and the reason for a very high yield.
☐ If I am near 65, I check how dividends affect my OAS.

Next in this topic → Part 7: Norbert’s Gambit: converting CAD to USD cheaply

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There are no affiliate or referral links in this post. This is general information, not financial, tax or legal advice; everyone’s situation is different. Figures were checked in October 2026 and can change.

Sources: CRA: Completing the T5 slip (gross-up and credit rates) · CRA: Lines 12000 and 12010 Taxable amount of dividends · CRA: Line 40425 Federal dividend tax credit · CRA: Line 12100 Interest and other investment income · Canada.ca: OAS pension recovery tax