Budgeting and Cash Flow

Budgeting and Cash Flow

Investment, Pension Income or Fixed Income Situation

For the investment, pension or fixed income situation, cash inflows are not derived by working but from investments or pensions. It is assumed that there is no income from a business. There would be no CPP deductions, EI deductions, pension deductions or other deductions typically found on a T4 slip from an employer. The main deduction in this case would be taxes. Taxes can be deducted at the source if it is pension income from any pension source (government or private) or an annuity. For investments, taxes are not deducted at source but would be payable when the tax return is filed. You may also have to pay the CRA installments if you consistently owe more than $3000 per year on your tax return. These installments are typically paid every 3 months throughout the year and would be a budget item to consider.

There are tax quirks with investment income which are not present with income from a job or a business. The 3 main quirks are the Canadian dividend tax credit, income from capital gains and foreign dividend withholding taxes. Without going into too much detail, the Canadian dividend tax credit “grosses up” income and then provides a Canadian dividend tax credit which means taxes from this type of income are lower than from working or having investments that earn interest income. This credit is for Canadian companies that pay dividends in a non-registered account (not an RRSP, TFSA, RESP or LIRA Locked in Retirement Account). Income earned from capital gains is taxed at half the rate of income derived from working, and if you have capital losses, they can offset capital gains, reducing taxes further. There are strategies that can generate income from capital gains, but this is beyond the scope of this series. The last quirk is dividend withholding taxes on foreign dividends. These are taxes on income from international dividends which would reduce your dividend income since these taxes are taken at the source. The rules for these dividend withholding taxes are complex but suffice it to say that these taxes can be accounted for by looking at the actual amount of dividends received each year.

How Do I Estimate My Investment Income?

Interest Income

If you know the rates and the amount invested do not change much from year to year, you can look at your bank statement and see how much interest was paid as of December 31 of a given year, and input this number into the budget for the following year. Another place to look for this information are the T3 or T5 tax slips that you receive each year from the institutions where your investments are held. You would not get a tax slip for small amounts of interest income in some cases, but if amounts are small, they can be ignored for the budget. Note that tax slips are only given for non-registered accounts to show you how much income you have earned each year. If you are building a budget using RRSP income, TFSA income or other registered account income, you would need to factor the amount of withdrawals you plan to make each year as well as any withholding taxes taken at the time of withdrawal.

If you have income from interest which is government or corporate bonds, GICs, bank accounts or products that are considered the safest investments you can buy, the type of income you would receive is likely going to be interest. To know how much income you would receive, you need to know how much money is invested (your principle or cost base) and the yield or interest rate that you are receiving on the money. If the interest rate is locked-in or is the same throughout the investment, the amount of interest income you would receive is the amount invested multiplied by the interest rate. If the rate is unpredictable or is changed at some point during the year, you can estimate using an average of what type of rate the investment typically generates. If it is a fixed rate that changes once or twice throughout the year, you can calculate the interest income for each portion of the year by calculating the amount invested multiplied by the interest rate multiplied by the portion of the year that you held the investment. If you had $20,000 invested at a 1% interest rate for 4 months, the interest income is $20,000 x 1% x 4 months / 12 months = $200 *4 /12 = $66.67. For the remaining 8 months, if the interest rate is 1.5%, the calculation is $20,000 x 1% * 8/12 = $133.33 for the remainder of the year. For timing purposes, you may also want to know what time of the year the interest pays out because it could be monthly, quarterly, annually or whenever you redeem the investment.

Dividend Income

If you have investments in equities or stocks, you may receive income in the form of dividends. These dividends can come from Canadian companies or foreign companies. The calculation is the same as for interest income, but instead of using an interest rate, you are using a dividend yield, or percentage of the amount invested paid out in dividends each year. Not all equity investments have dividends. If you hold equities that do not pay dividends, this section can be skipped. Canadian and international dividends have the same formula for calculation. The issue with dividends is that they are not guaranteed and therefore less predictable than interest. Using prior year bank statements and T3 or T5 slips is still useful for estimates. For timing, dividends are typically paid quarterly, but the cycle and pay date can vary in terms of which day of the quarter the dividend pays out. Some companies also pay dividends once a year, so be mindful of the payout schedule for each holding that you have.

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