Canadian savers are getting ready to make their final registered Retirement Savings Plan (RRSP) contributions to help reduce 2023 taxable income. Investors who missed the recent rally in the TSX are wondering which Canadian dividend stocks are still undervalued and good to buy for a self-directed retirement portfolio.
RRSP contribution space
The government lets Canadians contribute 18% of the previous year’s earned income to their RRSP accounts, up to a maximum. For the 2023 taxation year, the top RRSP limit amount is $30,780, which means the earned income limit in 2022 was $171,000. The maximum RRSP contribution limit in 2024 will be $31,560. That works out to 18% of 2023 earned income of roughly $175,333.
RRSP contributions can be used to reduce a person’s taxable income in the relevant year. In addition, the invested funds can grow tax-deferred inside the RRSP. When it comes time to remove the funds to cover retirement living expenses, the withdrawals are taxed as income. Ideally, the contributions are made when a person is in a higher marginal tax bracket than when the money is taken out of the RRSP.
Unused contribution space can be carried forward to future years. Young investors might decide to put savings in a Tax-Free Savings Account (TFSA) when they are in the early part of their careers and then shift savings contributions to their RRSP when their income puts them in a much higher tax bracket.
People can contribute to their RRSP up to December 31 of the year they turn 71. At that point, the government makes you convert the RRSP to an income vehicle, like a Registered Retirement Income Fund (RRIF) that pays out a minimum required amount each year.
It is important to note that company pension plans count against the RRSP contribution limit each year. For example, if a person’s RRSP deduction limit is $10,000 and they have company pension contributions of $8,000, there is only $2,000 left in free RRSP space. The employer calculates the pension adjustment and reports it on an employee’s T4 statement.
The Canada Revenue Agency itemizes the RRSP contribution limit and any carry-forward contribution room on your annual notice of assessment.
How dividend stocks can help build wealth
A popular RRSP investing strategy involves owning top dividend-growth stocks and using the distributions to buy more shares. This sets off a compounding process that can turn relatively small initial investments into substantial savings over time, especially when dividends increase every year and the share price drifts higher.
Good stocks to own tend to be ones that have long track records of dividend growth supported by rising revenue.
Fortis
Fortis (TSX:FTS) is a good example of a top Canadian dividend-growth stock. The company has increased the payout annually for the past 50 years and intends to boost the distribution by at least 4% per year through 2028.
Fortis gives investors a 2% discount on shares purchased under the dividend-reinvestment plan (DRIP). Investors can normally direct their online brokerage service provider to enroll in the DRIP offered by any stocks in the portfolio.
Long-term investors have done well with Fortis. A $10,000 investment in the stock 20 years ago would be worth about $75,000 today with the dividends reinvested.
TD Bank
TD (TSX:TD) is another good dividend stock to consider, especially when the share price dips, as it has over the past two years. TD trades for close to $85 per share at the time of writing compared to $108 in early 2022.
The bank remains very profitable, even as it sets aside more money to cover potential loan losses in the current environment of high interest rates. An economic slowdown and higher defaults will put pressure on earnings growth in the near term, but interest rates are expected to start to decline in 2024 or 2025, and that should set the economy up for a rebound.
Buying TD on pullbacks has historically proven to be a savvy move for patient investors. A $10,000 investment in TD stock 20 years ago would be worth about $80,000 today with the dividends reinvested.
The bottom line on RRSP investing
Fortis and TD pay good dividends that should continue to grow. There is no guarantee that the next two decades will deliver the same returns, but these stocks deserve to be on your radar. The strategy of buying top dividend stocks and using the distributions to acquire new shares is a proven one for building long-term wealth.
