Archive | Taxes

The Couch Potato Goes Abroad

Andrew Hallam’s Millionaire Teacher remains one of the best introductions to index investing. When I reviewed it three years ago, I stressed that Andrew writes with authority because he follows his own advice.

In his new book, The Global Expatriate’s Guide to Investing, Andrew shares more of his first-hand knowledge about managing an indexed portfolio outside your home country. Andrew left Canada in 2003 and spent years as a teacher in Singapore before settling (at least for now) in Mexico earlier this year. So he knows all about the challenges—and the surprising benefits—of being an expat investor.

Most of his book’s advice applies equally to homebodies: the first several chapters lay out the case for using a passive strategy, whether with plain-vanilla ETFs, a fundamental index strategy, or the Permanent Portfolio. Then he explains how expats can put these ideas into practice. I asked Andrew to elaborate on some of the key points for Canadians living abroad.

What are the most important tax issues that Canadian expat investors need to be aware of?

AH: So much depends on where the expat is living.

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Ask the Spud: Bond ETFs in Taxable Accounts

Q: Can you share your thoughts about the BMO Discount Bond (ZDB) and the Horizons Canadian Select Universe Bond (HBB) as long-term holdings in a taxable account? – D. F.

Earlier this year BMO and Horizons both launched bond ETFs specifically designed for taxable accounts. These two funds have very different structures, and each has its strengths and weaknesses. So let’s dig more deeply into each fund to help you decide which might be right for your portfolio.

Before we discuss these specific funds, let’s review the problem with holding traditional bond ETFs in non-registered accounts. Most bonds these days trade at a premium (higher than their par value), because they were issued when interest rates were higher. Premium bonds are perfectly fine in your RRSP or TFSA, but they are notoriously tax-inefficient and should not be held in non-registered accounts.

 Do you want a discount or a swap?

The BMO Discount Bond (ZDB), launched in February, is similar to traditional broad-market bond ETFs, such as the iShares Canadian Universe Bond (XBB), the Vanguard Canadian Aggregate Bond (VAB) and the BMO Aggregate Bond (ZAG).

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Tax Loss Harvesting Revisited

No one likes to see their investments plummet in value, but it’s going to happen many times over your lifetime. If you’ve got a strategy for tax loss selling, you can make the best of the situation by harvesting capital losses that can be used to offset capital gains. That gives you an opportunity to reduce or defer taxes in the future, or even recover taxes you paid in past.

In a blog post on September 26, I noted that Canadian equities had fallen by about 5% since the beginning of the month, which could have triggered one such opportunity. (A useful rule of thumb, courtesy of Larry Swedroe, says a security should be sold when the loss is at least 5% and at least $5,000.) If you had recently made a large purchase of the Vanguard FTSE Canada All Cap (VCN), for example, you might have sold it that week to realize a capital loss and then repurchased the iShares Core S&P/TSX Capped Composite (XIC) or a comparable fund. As long as the replacement ETF tracks a different index you’ll maintain your exposure to Canadian stocks while also steering clear of the superficial loss rule.

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After-Tax Returns on Canadian ETFs

When you invest in a non-registered account, you need to be concerned about more than just your funds’ performance: you also need to know how much of your return will be eaten up by taxes. Unfortunately, while regulators are strict about the way ETFs and mutual funds report performance, fund companies in Canada have no obligation to estimate after-tax returns—something that’s been required in the US since 2001.

To help address this problem, Justin Bender spent the last several months creating a calculator for estimating the after-tax returns on Canadian ETFs. He was inspired by Morningstar’s US methodology, but he made many significant changes to adapt it for Canada. The new methodology is fully explained in our latest white paper, After-Tax Returns: How to estimate the impact of taxes on ETF performance. We have also made our spreadsheet available for free download so DIY investors can experiment on their own. (The spreadsheet is protected so the formulas cannot be altered. However, we have included detailed descriptions of these formulas in the appendix to the white paper.)

The methodology is quite complex, but here’s an overview in plain English:

We begin by recording the ex-dividend dates for all the cash distributions an ETF made during the period being considered.

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Foreign Withholding Taxes in International Equity ETFs

It seems Canadian ETF providers are paying more attention to foreign withholding taxes these days. Not so long ago, you rarely heard anyone discussing this hidden drag on returns. But last month BlackRock announced a significant change to its iShares Core MSCI EAFE IMI Index ETF, ticker symbol XEF, which makes up the international equity component of my Global Couch Potato portfolio. The change was made specifically to reduce the impact of foreign withholding taxes.

When the fund was launched in April 2013 it simply held a US-listed ETF, the iShares Core MSCI EAFE (IEFA). That was a convenient way of getting exposure to the 2,500 or so stocks in this large index. Over the last three weeks, however, XEF has gradually bought up the individual stocks in the index and now holds them directly. According to BlackRock:

“XEF will generally no longer be subject to U.S. withholding taxes. While foreign withholding taxes will continue to apply to dividends paid on certain international equity securities included in the XEF Index, it is expected that the change in investment strategy implementation will reduce the overall amount of withholding taxes borne directly or indirectly by XEF.”

A refresher course on foreign withholding taxes

A few words of explanation will help here.

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Managing Multiple Family Accounts

Model portfolios like those I recommend are ideal for investors who have a single RRSP account. But life isn’t so simple once you’ve accumulated a significant portfolio: chances are you’ll be managing two or three accounts, and if you have a spouse there may well be a few more.

In most cases, it’s most efficient to consider both partners’ retirement accounts as a single large portfolio. In other words, there’s no my money and my spouse’s money: there’s only our money. This strategy has a couple of advantages: first, it allows the family to make the most tax-efficient asset location decisions. Second, it keeps the overall number of holdings to a minimum, which reduces transaction costs and complexity.

Meet Henry and Anne, who have a combined portfolio of $480,000. Let’s assume they are the same age and plan to retire at about the same time. Their financial plan revealed that a mix of 50% bonds and 50% stocks is suitable for their risk tolerance and goals. Anne has a generous defined benefit pension plan and therefore has little RRSP room: most of her personal savings go to a non-registered account.

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Calculating Adjusted Cost Base: A Case Study

If you’ve read our ironically titled white paper, As Easy as ACB, you understand how complex it can be to track the adjusted cost base of ETFs. You need to account for all purchases and sales of shares during your holding period and then adjust for any reinvested distributions, return of capital and share splits along the way. Since that paper came out, several readers have emailed to ask whether it’s really necessary to do all that work.

That’s up to each investor to determine, but I wouldn’t want the Canadian Revenue Agency to discover you were paying a lot less tax than you owed. And as we discovered recently with a client of our DIY Investor Service, taking the time to accurately calculate your adjusted cost base can also save you from paying unnecessary taxes.

Our client purchased 300 shares of the iShares S&P/TSX Composite Index ETF (XIC) in September 2005 and added another 200 shares the following year. She eventually sold the entire holding (which by then had more than doubled in value) in April of this year. On the surface that seems like a straightforward set of transactions,

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Rebalancing With Cash Flows

With stocks continuing to enjoy a roaring bull market, rebalancing is on the minds of many investors—or at least it should be. Disciplined investing starts with choosing long-term targets for the asset classes in your portfolio and making regular adjustments to stay on course. Rebalancing discourages you from chasing performance, timing the markets and taking inappropriate risk.

There are three main rebalancing strategies. The first is based on the calendar: you might rebalance annually, or even several times per year. (Many balanced funds, for example, rebalance every quarter.) The second is based on thresholds: a rebalance might be triggered any time an asset class is five percentage points off its target. Finally, you can rebalance with cash flows, buying underweight asset classes with new contributions or cash from distributions (or, if you’re drawing down your portfolio, selling overweight positions when you make withdrawals).

In the real world, most investors probably do some combination of all three, and that’s fine. But there’s a good argument to be made for emphasizing the cash-flow method.

Go with the flow

Rebalancing with cash flows is particularly useful for those making regular contributions. The idea is that you deposit cash in your account every month or so,

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A Trove of Tax Tips for Canadian Investors

If your long-term savings are all in RRSPs and TFSAs, consider yourself lucky. Using tax-sheltered accounts is easy compared with the plight of investors who are saving in non-registered accounts. From deciding on the right asset location, to harvesting losses, to calculating the adjusted cost base of your holdings, taxable investments are always a challenge. But André Fok Kam’s new book, Tax-efficient Investing for Canadians, will make the job easier.

There are countless books on taxes, but this is the first one I’ve seen that focuses specifically on investments, and it’s loaded with excellent advice. Here are three tips to give you a taste:

Be careful when reinvesting distributions. In the chapter covering the tax implications of mutual funds and ETFs, Fok Kam explains why distributions add no value: “Instead, they merely transfer value from the fund to its unitholders. Investors are enriched when the fund earns a return, not when it transfers value.”

Cash distributions can help pay living expenses if you’re drawing down your portfolio. But investors in the accumulation phase often reinvest all distributions, which is a potential problem at tax time,

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