Put Your Assets in Their Place

Couch Potato investors hear a lot about asset allocation, but asset location is also an important consideration. Asset location refers to the type of account you use to hold the stocks, bonds, cash and real estate in your portfolio. It’s important because the growth and income from your investments are treated in different ways by the taxman:

Interest from bond funds and bond ETFs (as well as individual bonds, GICs and money market funds) are taxed at your marginal tax rate, just like employment income.

Dividends from Canadian stocks are eligible for a generous dividend tax credit from the federal government. For the 2009 tax year, eligible dividends are first grossed up (increased) by 45% and declared as income; the investor then receives a tax credit of 19% on the grossed-up amount. Some provinces offer an additional dividend tax credit.

Foreign dividends are taxed at your marginal rate. In addition, if you hold US-listed ETFs, the Internal Revenue Service will take a 15% withholding tax on all dividends unless the funds are held in an RRSP.

Capital gains are profits earned from selling a security for more than you paid for it. You report 50% of your capital gains as income and pay tax on that amount. Mutual funds and ETFs must also pass along their capital gains to unitholders, although index funds are usually more tax-efficient.

Here’s a table highlighting the dramatic differences in how each type of investment income is taxed, assuming a marginal rate of 22%:

Canadian Capital
Interest Dividend Gain
Amount received $1,000 $1,000 $1,000
Taxable income $1,000 $1,450 $500
Federal tax (at 22%) $220 $319 $110
Dividend tax credit (19%) -$275.50
Total federal tax owing $220 $43.50 $110

The tax rates above apply to securities held in non-registered investment accounts. Registered accounts offer several opportunities to defer or avoid paying tax on investment growth and income:

  • If your retirement savings are in an RRSP or RRIF, you pay no tax on interest, dividends or capital gains until you withdraw the funds. At that time, you pay tax on the entire withdrawal at your marginal rate. (You can’t claim the dividend tax credit or enjoy the lower tax on capital gains.)
  • With a Registered Education Savings Plan (RESP), you pay no tax until you withdraw the funds. At that time, all the growth is reported as income in your child’s hands. You pay no tax on the amount you put into the account, since contributions were made with after-tax dollars.
  • In a Tax-Free Savings Account (TFSA), all the growth is tax-free, and no tax is payable when the funds are withdrawn.

So, what’s a Couch Potato to do with all this information? If you’re able to hold all your investments in an RRSP or other tax-deferred accounts, you don’t need to worry much about this at all. However, if you also hold ETFs or index funds in a taxable account, review your asset location to make sure you’re not paying more tax than you need to:

Canadian equities deliver their returns from lightly taxed dividends and capital gains. So if you need to hold some of your investments in a taxable account, start with Canadian stocks.

REITs pay generous distributions, but these are not considered dividends. The bulk of the payouts are classified as income and taxed at your full marginal rate. (The rest is usually return of capital.) REITs are therefore best held in a tax-sheltered account.

Income trusts, like REITs, pay most of their distributions as income. However, beginning in 2011, when trusts must convert to corporations, their distributions will start being classified as dividends and will therefore be eligible for the tax credit. For now, hold them in a tax-sheltered account if you can.

Bonds (as well as GICs and money market funds) are best held in a tax-sheltered account, since their interest is fully taxable at your marginal rate.

Preferred shares are sometimes considered fixed-income investments, but they pay dividends, not interest. For income-oriented investors who have no more RRSP or TFSA room, Canadian preferred shares may be a good choice in a taxable account because they’re taxed more favourably than bonds.

Canadian-listed ETFs that hold international stocks include the popular iShares XSP and XIN. Although these are traded on the TSX, their underlying holdings are foreign stocks, so the dividends are not eligible for the tax credit. These ETFs are best held in a tax-sheltered account. However, as Canadian Capitalist has pointed out, XSP and XIN (which simply hold US-listed ETFs in a Canadian wrapper) are still subject to the US withholding tax even if they’re held in an RRSP.

Dividends from US-listed ETFs are fully taxable in Canada and get dinged by the additional 15% withholding tax unless you hold the funds in an RRSP. Note that you still pay the withholding tax if the fund is held in an RESP or a TFSA. The good news is that you may be able to recover the withholding tax if you hold them outside an RRSP. A taxable account also allows you to buy and sell ETFs in US dollars and avoid currency exchange fees—most discount brokers do not allow you to hold US dollars in an RRSP. (Questrade and QTrade are the exceptions.)

Pulling all this together, here’s an example of how you might divvy up an ETF portfolio across different accounts with an eye toward keep taxes to a minimum:

Vanguard Total Stock Market (VTI)
Vanguard Europe Pacific (VEA)
Vanguard Emerging Markets (VWO)
iShares Canadian Bond (XBB)

iShares Canadian REIT Sector (XRE)
Cash (GICs or money market fund)

Taxable account (assuming no more RRSP or TFSA room)
iShares Canadian Composite (XIC)
Claymore S&P/TSX Preferred Share (CPD)

As you can see, tax planning is complicated, so if you have a large portfolio, consider seeking help from a financial or tax advisor.

117 Responses to Put Your Assets in Their Place

  1. John September 30, 2014 at 10:38 pm #


    Thanks for the response. I’ve thought about it a bit more and read up on what you posted (also this: http://canadiancouchpotato.com/2012/09/17/foreign-withholding-tax-explained/).

    VCN – Non-Reg due to no more room in TFSA after XEF & ZDB
    VUN – Non-Reg due to Foreign Withholding Tax recovery
    XEF – TFSA
    ZDB – Non-Reg

    How does that look? Only other thought is maybe it makes some sense to put a % of VCN in TFSA, wondering if you could shed some light.

    Thanks a lot!

  2. Canadian Couch Potato October 1, 2014 at 9:01 am #

    @John: Based on what you’ve explained this sounds like a reasonable strategy. Not sure what would be gained by putting VCN in the TFSA if it would mean removing some XEF to make room.

  3. John October 1, 2014 at 11:12 am #


    I guess that answers it for me! Thanks for the advice.

  4. Phil H October 1, 2014 at 8:26 pm #

    Hi @CCP

    Just opened my account and I.m about to allocate to my certain accounts. I will not be maxed out in tfsa or rrsp.
    Im confused to what account to put my Canadian etf in. This is what I have so far
    10% cash (TFSA)
    40% Bonds XBB (LIRA from previous job)
    25% Canadian XIU ?? ( do i do taxable if not maxed out)
    10% USA SPY in US$ (RRSP)
    15% International in US$ (RRSP)
    Thanks for your help

  5. Canadian Couch Potato October 1, 2014 at 8:57 pm #

    @Phil H: I can’t be too specific without knowing the details of your situation, but this looks generally good. I can’t think of any reason to put Canadian equities in a non-registered account as long as you have TFSA and RRSP room.

  6. Oldie October 1, 2014 at 9:18 pm #

    @CCP: Would it not be a reasonable strategy to put Canadian Equities in a taxable account on a long term basis? My reasoning would be that any positive return would be 1) Increase in value, which is non-taxable until sold, and then only at half marginal rate and 2) Dividends which would be taxed favourably for most Canadians. That would save RRSP and TFSA room for asset classes that are more in need of Canadian tax protection. Actually, I thought that was your underlying reasoning in your advice above to John regarding not shifting VCN from non-registered to TFSA.

  7. Nathan October 1, 2014 at 9:43 pm #

    @Oldie – but in this case Phil mentioned that the TFSA and RRSP are both not maxed out; no point in using a taxable account until they are.

  8. Oldie October 2, 2014 at 1:06 am #

    @Nathan: Right, I was forgetting that for myself the reason I was positioning a significant Canadian Equity investment in my taxable account was that I was actually needing some income now. So extracting some income as Canadian dividends was to me a painless decision. I suppose this might also work for some people in the accumulation phase whose income was low enough that the Canadian dividend was taxed negligibly so that it could be ploughed back into investments. That dollar amount has been taxed already, and will not be taxed when these secondary investments are eventually taken sold, (taxation being only on the eventual capital gain amount on the dividend, and this would be half the marginal rate). That would seem to me to beat keeping it in an RRSP, where dividends are not taxed now, but taxed at the full marginal rate at the time it leaves the RRSP, not to mention that the original investment’s capital gain will also eventually be taxed at the full marginal rate. But of course, I have not taken into account that the RRSP investments are all made with pre-tax dollars; my argument might be more appropriate for one’s TFSA.

  9. Nathan October 2, 2014 at 1:27 am #

    @Oldie: if you need the income, then I could see it for sure. If you’re just plowing distributions back into investments though, a TFSA is always going to be better than taxable. (Unless you end up with a capital loss, but it doesn’t really make sense to optimize for that!) Better to be taxed nothing than even a small amount. Plus, if you eventually run out of TFSA space and decide to move the Canadian equities out, nothing is lost. Your ACB will be whatever amount they’re worth when you move them out, so you only pay taxes on future gains. Plus, any gains earned while in the TFSA have effectively created more TFSA room for other investments.

    The RRSP argument is similar; the fact that you’re effectively investing pre-tax dollars cancels out the fact that funds are taxable on withdrawal.

  10. Sebastien October 2, 2014 at 9:34 am #

    Oldie: Using my Excel workbook, you can find the optimal way to distribute your money between your accounts. It does as you said. RRSP should hold international equity and US equity before Canadian Equity. If there is room left, then you can put Canadian equity in your RRSP. But before any kind of equity, you have to optimize the distribution of fixed income between RRSP and TSFA. The good news is that my Workbook does all the calculation for you. The best split between RRSP and TFSA is calculated so there is the maximum tax-free money in the RRSP.

    Here is the link for my Workbook: https://drive.google.com/file/d/0B6x4qQK9cyjheDNXY29SeEtSS3M/edit?usp=sharing

    The sample datas are based on the post found at: http://www.moneysense.ca/taxes/making-smarter-asset-location-decisions

    You have to download the file to be able to use it. Google Docs misses lot of the new Office 2010+ functions. Please make sure you use Office 2010 or later to open this file. Using Office 2007 or older would cause issue with formulas using specific functions.

    * Check with your advisor to make sure it is right for your situation. I am not responsible for any loss that can happen by using this Workbook.

  11. B October 8, 2014 at 12:34 pm #

    Young investor here – I have maxed out my TFSA, but I’m wondering if I should even bother contributing to my RRSP? As many are pointing out these days, it seems like a good bet that tax rates will be higher at my retirement, and that I may be better off taking the tax hit now.

  12. Canadian Couch Potato October 8, 2014 at 12:46 pm #

    @B: If you’re a long way from retirement, do you really want to bet about what tax rates will be decades in the future? Unless you’re in a very low tax bracket now an RRSP will likely offer you valuable some valuable tax deferral. There’s also an important behavioral benefit to keeping your long-term savings in an RRSP: you’re far less likely to dip into it before retirement.

  13. Paola October 17, 2014 at 2:39 pm #

    Hi. I’m trying to move from mutual funds to some TD e-series and follow the couch potato portfolio approach. My main concern is how to distribute our monies within TDB900, TDB902, TDB911 and TDB909 and be tax efficient. So, which funds are recommended for our TFSA and which for our non-register account?


  14. Canadian Couch Potato October 17, 2014 at 2:43 pm #

    @Paola: In general, if you need to hold investments in non-registered accounts, Canadian equities are the best choice, followed by US equities, and then international equities. A bond fund like the TD Canadian Bond Index will be very tax-inefficient and is not a good choice in a non-registered account.


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