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investor clinic

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I am 71 and will soon be retiring. I receive Old Age Security and my income now is just on the cusp of the clawback threshold. I have money to invest and am considering buying some dividend shares for income. However, the "grossed-up" dividends would be included in my income and put me into the OAS clawback zone. Taking this into account, am I better off owning dividend stocks or investing in interest-bearing securities that aren't subject to the gross-up?

I asked Jamie Golombek, managing director of tax and estate planning with CIBC Wealth Advisory Services, to crunch the numbers.

His conclusion: "You are still better off earning dividend income than interest income, even with the OAS clawback."

Here's why:

For 2015, the OAS clawback threshold is $72,809. "If you are 'on the cusp' of this threshold, you are in the federal bracket of 22 per cent for ordinary income, including interest income. Your federal marginal tax rate on eligible Canadian dividend income, however, is under 10 per cent at that level of income," Mr. Golombek said.

Dividends are grossed-up by 1.38 for income tax purposes, so receiving dividends will indeed increase the clawback, which is 15 per cent of every dollar above the threshold. Taking the clawback into account – and the tax reduction the clawback entails (because OAS is taxable) – the net federal effective tax rate on dividends is 25.8 per cent at this income level.

However, that is still lower than the effective tax rate, including the OAS clawback, of 33.7 per cent for interest income, he said.

"In other words, despite the higher clawback of OAS associated with dividend income, your effective tax rate is still lower with eligible dividends and thus you will be better off than if you earned the same amount of interest income," he said.

The dividend gross-up will also reduce the age credit, but the impact is small, he said. It's also worth noting that many dividend stocks are yielding north of 4 per cent, whereas yields of guaranteed investment certificates, government bonds and even many corporate bonds are substantially lower. So taxes and clawbacks aren't the only considerations here – so is the absolute level of income you can expect from dividends versus interest.

Finally, keep in mind that these calculations are based on a specific income level and incorporate federal tax only. Results will vary depending on the province and income of the individual.

I bought some exchange-traded funds online and noticed that, as with regular stocks, there was still a "bid" price and an "ask" price. Surely the price of the ETF is determined by the current prices of all of the stocks contained in the fund. How do the bid and ask fit into this?

First, a few basic definitions.

The bid is the highest price a buyer is willing to pay for a security. The ask is the lowest price a seller is willing accept. The difference between these two prices is known as the bid-ask spread, and with the largest, most liquid stocks and ETFs, it's usually very narrow.

For example, on Friday morning, shares of Royal Bank of Canada (RY) were quoted with a bid of $74.71 and an ask of $74.72. If you had wanted to sell your Royal Bank shares, you could have done so at $74.71. And if you had wanted to buy, you could have found a willing seller at $74.72.

With thinly traded stocks, however, bid-ask spreads are often wider. Shares of Pizza Pizza Royalty (PZA), for example, were quoted yesterday with a bid of $13.36 and an ask of $13.45.

Just like stocks, ETFs also have bid-ask spreads, and they are largely a function of the spreads of the ETF's underlying holdings. The iShares S&P/TSX 60 index ETF (XIU), for instance, invests in common shares of the largest Canadian companies and typically has a bid-ask spread of a penny. But the iShares S&P/TSX Small Cap Index ETF (XCS), whose holdings are generally less liquid, had a spread of 7 cents when I checked on Friday.

Built into the ETF's bid-ask spread is also a small profit margin for the market maker, who provides liquidity by offering to buy and sell units when necessary. The market maker ensures that there is always a bid and ask at which to trade, although investors are free to buy and sell within these "goalposts."

For small ETF orders, a spread of a few cents isn't going to make much difference in the long run. But if you trade frequently or enter a large order, the costs can add up. To avoid surprises when you buy or sell securities, it's a good idea to keep an eye on bid-ask spreads and, where appropriate, use limit orders specifying your maximum buy price and minimum sell price.

Editor's note: An earlier digital version of this story incorrectly stated the amount for the willing seller of Royal Bank of Canada shares. This version has been corrected.