Foreign Withholding Tax: Which Fund Goes Where?

My previous post on foreign withholding taxes included a lot of information for investors to puzzle over. But unless you’re an accountant, you probably don’t care too deeply about the finer details. Most investors just want to answer a simple question: which fund should I put in which account?

Recall from the earlier post that there are five broad categories of funds you can use for US and international equities:

A. Canadian mutual fund or ETF that holds US or international stocks directly.
B. US-listed ETF that holds US stocks.
C. US-listed ETF that holds international stocks.
D. Canadian ETF that holds a US-listed ETF of US stocks.
E. Canadian ETF that holds a US-listed ETF of international stocks.

To help you make the most tax-efficient choice for each type of account, see the tables below. I’ve specified which of the above fund categories are the most tax-efficient, and which ones carry the largest withholding tax burden. Then I’ve included some comparisons of specific funds. In each case, the pairs track the same index and use the same currency hedging strategy. Once again, a big thanks to Justin Bender at PWL Capital for helping me sort through these details.

An important note before you make your decision: foreign withholding taxes are just one of many costs of investing, so they should not be the only factor in your fund choices. Management expense ratios are just as important: it makes no sense to pay an extra 0.50% in MER to save 0.30% in withholding taxes. Similarly, a US-listed ETF may be more tax-efficient than a Canadian one, but your overall cost will still be higher if you’re paying 1.5% in currency exchange fees. Make sure you’ve thought this through before making any changes to your portfolio.

Even more important, you need to consider your income tax situation when deciding where to hold your fund. While holding foreign equities in a non-registered account (as opposed to an RRSP) allows you to claim the foreign tax credit, the dividends are taxed at your full marginal rate, and any capital gains are also taxable. In an RRSP, these taxes can be deferred until retirement. Justin illustrates this idea with a dramatic example on his blog.

US Equities

For non-registered accounts choose A, B or D.

TD U.S. Index (TDB902) is equal to iShares S&P 500 (IVV)
TD U.S. Index Currency Neutral (TDB904) is equal to Vanguard S&P 500 Hedged to CAD (VSP)
Vanguard Total Stock Market (VTI) is equal to Vanguard US Total Market (VUN)
BMO S&P 500 (ZSP) is equal to Vanguard S&P 500 (VFV)
iShares US Fundamental
(CLU.C)
is equal to PowerShares FTSE RAFI 1000 (PRF)

 

For RRSPs choose B. Avoid A and D.

iShares S&P 500 (IVV) is more tax-efficient than TD U.S. Index (TDB902)
Vanguard S&P 500 Hedged to CAD (VSP) is equal to TD U.S. Index Currency Neutral (TDB904)
Vanguard Total Stock Market (VTI) is more tax-efficient than Vanguard US Total Market (VUN)
BMO S&P 500 (ZSP) is equal to Vanguard S&P 500 (VFV)
PowerShares FTSE RAFI 1000 (PRF) is more tax-efficient than iShares US Fundamental
(CLU.C)

International equities

For non-registered accounts choose A. Avoid C and E.

TD International Index (TDB911) is more tax-efficient than
Vanguard FTSE Developed Markets (VEA)
TD International Index Currency Neutral (TDB905) is more tax-efficient than
iShares MSCI EAFE CAD-Hedged (XIN)
iShares International Fundamental (CIE) is more tax-efficient than
 PowerShares FTSE RAFI Developed Mrkts ex-U.S. (PXF)
Vanguard FTSE Emerging Markets (VWO) is equal to  Vanguard FTSE Emerging Markets (VEE)

 

For RRSPs choose A or C. Avoid E.

 TD International Index (TDB911) is equal to Vanguard FTSE Developed Markets (VEA)
 TD International Index Currency Neutral (TDB905) is more tax-efficient than
iShares MSCI EAFE CAD-Hedged (XIN)
 iShares International Fundamental (CIE) is equal to  PowerShares FTSE RAFI Developed Mrkts ex-U.S. (PXF)
 Vanguard FTSE Emerging Markets (VWO) is more tax-efficient than
 Vanguard FTSE Emerging Markets (VEE)

 

155 Responses to Foreign Withholding Tax: Which Fund Goes Where?

  1. AJ April 2, 2015 at 6:05 am #

    I opened up a TD Waterhouse TFSA account a week back and ordered all the below e-series index funds in the account:

    TDB900
    TDB902
    TDB909
    TDB911

    Should I rather move TDB902 and TDB911 in a non registered account?

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