Insights & Resources

Dividends can feel like the “safe” way to retire. Your portfolio pays you, you don’t sell anything, and it all feels steady.

But retirement plans don’t usually go sideways because someone picked the wrong ETF. They go sideways because the plan creates the wrong type of taxable income at the wrong time. Dividends and interest can quietly raise what shows up on your tax return, even if you didn’t need the cash. And once Old Age Security (OAS) enters the picture, higher income can also mean clawback.

We go over a simple framework that helps: forced income versus optional income. It also covers why capital gains can be a useful lever for Canadians who want more control over taxes in retirement, where dividends can still fit, and the real-world risks of leaning too hard on gains.

Forced income vs. optional income

A lot of people set the goal as “passive income.” The thinking is: if the portfolio throws off dividends, you can live on the dividends and never touch the principal. It sounds safe. It feels like getting a paycheque without work.

Here’s the thing: the CRA doesn’t care what feels safe. The CRA cares what shows up on your tax return, and when it shows up.

A clean way to think about retirement cash flow is in 2 buckets:

• Forced income: Income that shows up on your return each year whether you need it or not.
• Optional income: Income you can often choose to trigger (or delay), depending on your needs.

Interest is forced income. Dividends are forced income. Even if you automatically reinvest them and never spend a dollar, the tax slip still arrives and the taxable income still happened.

Capital gains are usually different. In most cases, the gain isn’t taxable until you sell. That timing control is a big deal. It’s like the difference between a light switch and a dimmer switch. You can often turn income up in years where it’s cheaper (tax-wise) and down in years where it’s expensive.

And “expensive” doesn’t just mean a higher tax bracket. Retirement has plenty of income thresholds and benefit thresholds, plus uneven years: retiring before CPP and OAS start, severance, a business sale, large medical costs, charitable donations, or a one-time big purchase. In those situations, flexibility matters.

If your portfolio is built to spit out forced income every single year, you can end up paying tax at the worst times. Not because you did something reckless, just because the structure boxed you in.

Capital gains vs. interest income

In Canada, interest income is both simple and (often) painful. A dollar of interest is a dollar of taxable income. No special treatment. So if you’re earning interest in a non-registered account from things like GICs, savings accounts, or certain bond funds, that can become a quiet tax leak over time. It may not feel dramatic, but you’ll often notice it when your tax bill is higher than expected year after year. Under current rules, the capital gains inclusion rate is 50%. That does not mean you pay 50% tax. It means 50% of the gain is included in taxable income.

For example:

• You sell an investment and realize a $100,000 capital gain.
• Only $50,000 shows up as taxable income.

Now compare that to earning $100,000 of interest in the same year, using a 40% combined marginal tax rate in that year:

• $100,000 of interest could cost about $40,000 in tax.
• A $100,000 capital gain could cost about $20,000 in tax, because that 40% rate applies to $50,000 of taxable income.

Same economic profit, very different tax bill.

Then there’s the second advantage: timing. You can often decide when to sell and trigger a gain. Interest just shows up when it shows up. So if you’re building wealth in a non-registered account and you want tax flexibility later, a portfolio that’s heavy on interest income can make retirement planning harder than it needs to be, even if it feels stable month to month.

When dividends help and when they hurt

Eligible Canadian dividends can be tax-efficient in the right situation because of the dividend tax credit. That’s real, and it can be helpful. Where people get into trouble is when “dividends can be tax-friendly” turns into “dividends are always better.”

There are 2 common ways this backfires:

1. Dividends can be forced income in a non-registered account: If you don’t need the cash, you can reinvest them. But the taxable income still happened. If your plan was to keep taxable income low in certain years (for example, early retirement before CPP and OAS start), dividends can make that harder.
2. Dividends can inflate key income figures because of the gross-up: Eligible dividends are grossed up on your tax return. In plain English, the income number that hits your return can be higher than the cash you actually received. That’s especially important in retirement, where the “income number” affects more than just tax brackets.

OAS clawback: How dividends can become an income multiplier

This is where a lot of people get surprised. The OAS recovery tax (often called the clawback) is based on your net income, using prior-year income. For July 2026 to June 2027 OAS payments, the recovery tax starts at $93,454 of net income (based on the prior year’s income). Once you’re above that threshold, the recovery tax is 15% on the income over it.

So it’s not just “a bit more tax.” It can be “a bit more tax” plus “lose some OAS.” That’s why it can feel like a multiplier.

For example: If you’re 67 and your net income is $103,454, that’s $10,000 above the threshold. The recovery tax would be about $1,500 (15% of $10,000), on top of regular income tax.

Dividends can push net income higher. And eligible dividends can push it higher than you expect because of the gross-up. Someone might feel like, “I only received $50,000 of dividends,” but the net income used in the clawback formula can end up meaningfully higher than the cash received. That can push a person over the line when they are trying to stay just under it.

Capital gains can be easier to manage because you can choose how much to realize. If you want to keep net income just below the threshold in a given year, you can often:

• Sell a bit less,
• Sell a holding with a smaller embedded gain, or
• Wait until next January.

With dividends, you generally don’t get that choice.

Please note: “tax rate” and “benefit clawback” are two different problems. You can have a reasonable marginal tax rate and still get clipped by clawback if your net income number gets inflated.

Building retirement cash flow

A practical retirement plan still needs cash flow. The answer isn’t “avoid dividends at all costs.” It’s to think like a total-return investor with a cash plan, not just an income investor with a yield target.

For example: Susan is 55, lives in Ottawa, and has $1,200,000 saved across a mix of accounts. Her approach is boring in the best way. She holds broad-market, growth-focused ETFs, and she plans withdrawals like a runway.In her early retirement years, before CPP and OAS, she expects her taxable income to be lower. That’s when she can sell a little each year and realize capital gains gradually, instead of having dividends and interest determine her taxable income for her. She also pays attention to where things sit (account and asset location):

• TFSA: Withdrawals don’t add to taxable income, which makes it a powerful flexibility tool. The 2026 TFSA annual limit is $7,000, and that room can add up quickly over time for a couple.
• RRSP: Still a great tool, but withdrawals later are fully taxable as regular income. You want a plan for when and how you draw it down.
• Non-registered: Often a home for growth assets because capital gains can be more forgiving than interest, and you control the timing.

Susan also keeps a cash buffer so she’s not forced to sell equities in a market drop. In the script, that buffer might be 1 to 2 years of spending, depending on comfort.

The point isn’t to build a portfolio that never pays dividends. The point is to avoid a portfolio where the only way you “get paid” is by creating taxable income year after year, whether you need it or not.

The risks of relying on capital gains

Capital-gains-focused investing can give you flexibility, but it’s not magic. There are real risks, especially as you approach and enter retirement.

• Sequence-of-returns risk is the big one. If your plan is to fund spending by selling assets and markets drop early in retirement, selling low can do long-term damage. This is exactly why the cash buffer matters, and why diversification matters (not just owning a handful of “winners”).
• Liquidity risk is another. If your plan depends on selling something that’s not easy to sell quickly, like a concentrated stock position, certain real estate, or private investments, you can get stuck when you need cash most.
• Behavioural risk. People hear “capital gains are tax-efficient” and translate it into “growth at any cost.” That’s how you end up overconcentrated, underinsured, and stressed every time the market sneezes.

Build the cash-flow plan first, then choose investments

Retirement income isn’t just about what your portfolio earns. It’s about what shows up on your tax return, and when.

Interest and dividends can be forced income, tax slips arriving whether you need the cash or not. Capital gains are often optional income, where you can usually control timing. That one detail can help you stay under lines like the OAS recovery threshold and create room for smarter RRSP draws, charitable giving, and planning around lumpy years (like a severance or a business sale).

If you want your money to fund life, not force tax, build the cash-flow plan first, then pick the investments.