Rule #7 Maximize income in AFTER TAX money.

If, as a big severance package, your company offered you $60000 in any of the following income streams: pension income, capital gains income, employment income, or dividend income, what kind of income would you choose?  Did you think about the taxes?  Most people don't.

I hate paying income taxes. I wont go into it in any detail because it gets political... and I only talk politics if I have a beer in front of me, and I don't right now, so you are spared the rant.  But with that said, we all hate paying taxes, especially on income.  Doesn't it make sense then to try and minimize the amount of tax one pays on your income?  Sure it does. This is called tax avoidance and it is perfectly legal... structuring your income in such a way as to be tax efficient.  I was introduced to this way of thinking about a decade ago when I came across a blog talking about the virtues of dividends... Canadian Corporation Dividends in particular.  There is something called the Canadian Enhanced Dividend Credit, and I won't bore you with details of it, only to say that it results in a lowering of the marginal income tax rate on those dividends.  You can find out more about it here.  

For those who don't know what a dividend is, its a when a company shares a portion of its earnings with shareholders by sending them a cheque... usually quarterly throughout the year.  Those companies have already paid taxes on those earnings, so you don't have to pay as much taxes as you would if it was standard employment income.  Let's have a look at a couple scenarios, where income could be from one of these different streams...  Employment, Capital Gains, RRSP or RRIF withdrawal (remember its taxed when you take it out), Dividends from American Corporations, Dividends from Canadian Corporations (those eligible), and other income.  "Other Income" could come in the form of a pension, rental property, royalties, typical government benefits, some income from REITS, servers tips etcetera.... all of which are taxed at the same rate as employment income.  I don't include business income as I have no experience with owning my own business, nor do I know the intricacies that go with it. 

The two scenarios are $60000 and $100000 in annual income.  The income tax regime is Federal and Ontario, Canada.  The basis of the calculations is from the taxtips.ca calculator page where you can run your own scenarios.

So the Total in-pocket amount is the most important column because thats the one that tells you how much you get to keep.  Notice the big difference in taxes from the Investment rows such as Capital Gains and Canadian Dividends (eligible) in comparison to the Employment, RRSP/RIF Withdrawal, and Other Income rows.  Markedly different isn't it. If you made $60000 in Canadian Dividends you would get to keep 97.6% of it, vs the 80% you'd get to keep in employment income.  Note that as an employee you would also be required (don't get me started) to pay CPP and EI premiums which will run you another $3000 a year or so in tax obligations that you wouldn't have to pay if you made your income from dividends or capital gains.  Again with $100000 income, the investment income rows fair substantially better in tax treatment.  When I recognized this a decade ago, I started thinking that there was a type of income that I wanted more of, and other kinds of income that I wanted less of.  It was one of those "Eureka!" moments for me.

So... 

Guess what kind of income I prefer. Then guess what I look for when I'm building an investment portfolio.

Rule #2 "Lotteries are taxes on the stupid"

Rule #2 is pretty straight forward.  We don't play the lottery or do any other gambling where the odds are not stacked in our favour (and none are).

I played the lottery once about 14 years ago. It was one of those deals where someone from the office went around and convinced everyone to chip in a buck and then he went and bought a bunch of tickets for the department and if we won the Lotto 6/49 we would split the pot.  I quickly forgot about it, and then next week this person came around and asked me for another dollar.  "Is this going to be a regular thing?" I asked. "Yes! Now that we have our numbers picked, we have to keep playing them or someone else might take our winnings."  I decided there and then that I would cut my losses and not participate in the weekly Lotto pooling.  Being a numbers guy, I was keenly aware of the odds of winning the big pot of the Lottos 6/49 are low - 1 in 14 millions or so - so low that its like pissing money away... and if I am going to piss money away, I might as well do it drinking beer with buddies instead.  I at least see value in the socialising that goes along with the beer drinking.

Some polling shows that in some demographic groups of Canadians, 30+% expect a lottery win to fund their retirement.  This is shocking.  And the government is an accomplice to this ridiculousness.... it puts out all these advertisements that prey on people's fantasies of getting rich without having to work or save for it.  Sure, "Dream of all the stuff you could buy with $50 million dollars.... Every week somebody gets a big cheque and all they had to do was buy a ticket... This week it could be you!"   Approximately half of 6/49 revenue is returned to winners and the other half goes to the government... and its not unreasonable to think that some of that money goes to support people who haven't looked after themselves, because they were too busy buying lottery tickets instead of saving their money!

I view lottery tickets, and gambling in general, as "Taxes on the Stupid", or perhaps "ill-informed" would be a more PC way of describing it.  It sounds harsh but I believe it to be true...  If you remind yourself what the odds really are its baffling that people play it at all.  I did a quick calculation and here is an interesting way to look at it:  If a person played once a week from age 20 to age 80, that person would have to play 4500 lifetimes before the odds would go in your favour... and then when you did win, you would only get half of your money back.  Thats right, 4500 lifetimes... Amazing!

I don't want to tell people how to spend their money, and if they are truly doing it because they get a rush out of the beyond-longshot chance they might win, good for them.  But if people think the lottery is going to fund their retirement, they need a good shake.