How U.S. Dividends Affect Canadians’ Dividend Income And Its Growth

I’m a Canadian who invests in U.S. dividend stocks. So, I thought it’d be useful to explore how U.S. dividends affect my income and income growth. Is it worth it to buy and hold U.S. dividend stocks when Canadian eligible dividends are more favourably taxed?

First, I’ll look into the effective dividend yield and effective dividend growth when receiving U.S. dollar-denominated dividends as a Canadian. Then, I’ll discuss how to reduce the income tax on U.S. dividends for Canadians. Lastly, I’ll discuss why it may be worthwhile to hold U.S. stocks even with increased uncertainty due to fluctuating foreign exchange rates.

The effective dividend yield

On the Toronto Stock Exchange, I hold stocks that pay U.S. dollar-denominated dividends. They include Brookfield Infrastructure Partners L.P. (TSX:BIP.UN)(NYSE:BIP), Brookfield Renewable Partners L.P. (TSX:BEP.UN)(NYSE:BEP), Brookfield Property Partners L.P. (TSX:BPY.UN)(NYSE:BPY) and Algonquin Power & Utilities Corp. (TSX:AQN)(NYSE:AQN), which yield roughly 4-6%.

This group of stocks has juicy yields partly because the U.S. dollar has been strong against the Canadian dollar.

I also get some nice yields of 4-8% from U.S. companies, such as Pfizer Inc. (NYSE:PFE), and Omega Healthcare Investors, Inc. (NYSE:OHI). However, the effective yield from these U.S. companies will be higher while the U.S. dollar remains strong against the Canadian dollar.

A Strong USD boosts current income

Essentially, a strong U.S. dollar (against the Canadian dollar) boosts my effective income today. However, if the U.S. dollar weakens (against the Canadian dollar), my effective yield from these companies would decline.

For the first group of stocks, depending on your brokerage, you may be able to call in and ask for the dividends to be paid in the U.S. dollar instead of having the brokerage automatically convert it toe Canadian dollars and possibly take a cut while at it. This only works for brokerages that allow holding of cash in U.S. dollars in the trading accounts.


The effective dividend growth

The effective dividend growth affected by fluctuating foreign exchange rates is best illustrated with an example.

The Algonquin management aims to increase its dividend per share by 10% per year through 2021. However, let’s keep in mind that those are U.S. dollar-denominated dividends.

Assuming I’d receive US$1,000 of dividends from Algonquin this year, and I make no further investments in the name, the effective dividends I’d receive in Canadian dollars could be as follows.

Forex rate US$1->C$1.30 ->C$1.25 ->C$1.20 ->C$1.20 ->C$1.20
Year 2017 2018 2019 2020 2021
US$ dividends $1,000 $1,100 $1,210 $1,331 $1,464.10
C$ dividends $1,300 $1,375 $1,452 $1,597.20 $1,756.92

A weakening USD reduces effective dividend growth

If the U.S. dollar weakens, my effective dividend growth (in Canadian dollars) from Algonquin will be lower than 10% per even if the company manages to hike its dividend by 10% a year.

How to reduce income tax on U.S. dividends

There’s a 15% withholding tax on qualified U.S. dividends for Canadians if the U.S. shares are held in non-registered, TFSA, or RESP accounts. So, for U.S. stocks that pay juicy yields, consider holding them in RRSPs or RRIFs to avoid the withholding tax.

In a TFSA, the withheld tax is non-recoverable. In a non-registered account, it’s recoverable via claiming a foreign tax credit.

Diversification

Of course, it’d be smart to have bought U.S. stocks when the loonie and the greenback were near at par. After all, the U.S. dollar typically converts to more than US$1->C$1.20.

However, even as “expensive” as U.S. dollars are now, there’s the diversification benefit of buying U.S. stocks. The Canadian stock market is dominated by the Financials, Energy, and Materials sectors. They roughly make up 37%, 20%, and 13% of the S&P/TSX Composite Index.

On the U.S. market, Canadians can diversify into the sectors of Information Technology, Health Care, Consumer Staples, and Consumer Discretionary. Put companies like Apple Inc. (NASDAQ:AAPL), Amgen, Inc. (NASDAQ:AMGN), Colgate-Palmolive Company (NYSE:CL), and Starbucks Corporation (NASDAQ:SBUX) on your radar today!

This is not to say that you should pay any price just to gain diversification. Just like any investment, you can’t go wrong by buying quality companies at the right valuations. With the “expensive” U.S. dollar, it makes it all the more important to go for value.

This is a standalone article, which originated from my Seeking Alpha article at How Do Foreign Dividends Affect Your Dividend Income And Its Growth?

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Disclosure: At the time of writing, I own shares of Brookfield Infrastructure, Brookfield Renewable, Brookfield Property, Algonquin, Pfizer, Omega Healthcare, Apple, Amgen, and Starbucks.

Disclaimer: I am not a certified financial advisor. This article is for educational purposes, so consult a financial advisor and or tax professional if necessary before making any investment decisions.

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