RBC Direct Investing recently became the first bank-owned brokerage to allow Canadians to hold US dollars in registered accounts, such as RRSPs and Tax-Free Savings accounts (TFSAs).

This is a welcome move, and we hope the other banks will follow suit. (Questrade and Qtrade have allowed US dollars in RRSPs for some time.) The cost of converting loonies to greenbacks in an investment account is significant — indeed, it’s the main reason why Canadians are often reluctant to use low-fee ETFs from US providers.

But holding US dollars in a registered account also raises a number of practical questions. A reader, Graham R., emailed to ask how US-dollar transfers to RRSPs are treated with respect to contribution limits. For example, let’s say he moves $10,000 US into his retirement account today. Early in 2011, before tax time, the brokerage will send Graham a tax slip indicating the amount of his RRSP contributions. Will this amount be indicated in US or Canadian dollars?

I spoke to Michael MacDonald, head of business strategy at RBC Direct Investing, who clarified how this works. When you deposit US dollars into a registered account, the brokerage records the contribution in the equivalent amount of Canadian dollars. (They use the exchange rate set at the end of the previous day.) For example, if the US dollar is currently valued at $1.05 Canadian, then a $10,000 US deposit would count as an RRSP contribution of $10,500 CAD.

Watch out for overcontributions

Graham was concerned that confusion about these rules might cause investors to accidentally overcontribute to their RRSPs and incur a penalty. That risk seems small today with the US and Canadian dollars so close to par, but we’d be foolish to presume that our dollar is going to remain this strong forever. (Let’s not forget it was worth $0.77 US as recently as the spring of 2009.)

The good news is the CRA gives you a little breathing room: you’re allowed to exceed your RRSP contribution limit by $2,000 without penalty. (After that, overcontributions are taxed at 1% a month.) Note, however, that you can’t claim excess contributions on your tax return. If Graham’s RRSP limit this year is $10,000 and he makes a US-dollar contribution valued at $10,500 CAD, he won’t get penalized, but he can only claim a $10,000 income deduction.

As 70,000 investors learned last year, it can be just as costly to overcontribute to a Tax-Free Savings Account. The annual limits are low ($5,000, plus any amount carried over from previous years), and every excess dollar is taxed at 1% per month. If an unwitting investor transfers $5,000 US into her TFSA when the loonie is worth US$0.85, the overcontribution penalty would be more than $100.

Before you make the switch

Some other notes for investors who considering taking advantage of dual-currency accounts at RBC Direct Investing:

  • The option is available for the whole range of retirement accounts, such as Registered Retirement Income Funds (RRIFs) and Locked-In Retirement Accounts (LIRAs). The one important exception is Registered Education Savings Plans (RESPs), which cannot hold US dollars.
  • To move US dollars in and out of your RBC Direct Investing account, you’ll need to open a US-dollar bank account with RBC. You can’t use a US-dollar account from another bank.
  • No US-dollar bank account? You might consider using Norbert’s gambit, a way of sidestepping currency conversion fees in an investment account. Let’s say you want to buy $10,000 worth of a Vanguard ETF. You could deposit this sum in Canadian dollars, convert it using the gambit, then buy the ETF in US dollars. (This technique can be complicated, so read up on it first and employ it at your own risk.) This would also eliminate any confusion about RRSP or TFSA contribution limits, since the initial deposit would be in Canadian dollars.
  • US-listed ETFs are not eligible for dividend reinvestment plans through RBC — only individual stocks in the S&P 500 are eligible. But there’s still a benefit for investors who use US-listed funds: with a dual-currency account, you can receive dividends in US dollars and there’s no forced currency conversion. RRSP clients of all the other bank brokerages currently get dinged by foreign exchange fees of about 1.5% every time their ETFs pay a distribution.

The information in this post should not be construed as tax advice. Consult an accountant or other qualified advisor if you are unclear about any tax implications of using US dollars in a registered account.