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.
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 | Â Vanguard FTSE Emerging Markets (VEE) |
For RRSPs choose A or C. Avoid E.
| Â TD International Index (TDB911) | is equal to | Vanguard FTSE Developed Markets (VEA) |
| Â TD International Index Currency Neutral (TDB905) | is more tax-efficient than |
iShares MSCI EAFE CAD-Hedged (XIN) |
| Â iShares International Fundamental (CIE) | is equal to | Â PowerShares FTSE RAFI Developed Mrkts ex-U.S. (PXF) |
| Â Vanguard FTSE Emerging Markets (VWO) | is more tax-efficient than |
 Vanguard FTSE Emerging Markets (VEE) |
So . . . does this mean there are no good options (when it comes to US withholding tax) for holding US Equities in a mutual fund in an RRSP? i.e. if you want to do a weekly or bi-weekly contribution, ETFs are out and you need to go mutual fund, but you can’t hold US mutual funds in RRSPs.
Or is this one area where one of the mutual funds that use derivatives rather than directly holding the stocks (such as the Altamira US Index) would work in your favour? If they are holding derivatives rather than the actual stocks do they avoid US withholding taxes?
As mentioned above, the best option IMO is to use the lowest cost CAD-denominated US mutual fund you can buy for your regular US equity contributions – ideally TD’s US index e-fund in CAD. Then every year or so, sell all except purchases made in the past 30 days*, do a single Norbert’s Gambit, and buy VTI in one chunk. Minimal commissions and only half a year’s money on average in the mutual funds.
*double-check the minimum holding period for your fund
@HMS: Nathan’s suggestion is indeed one option, though it’s more hands-on than many investors will enjoy. (I’ve heard from many who are intimidated by Norbert’s gambit.) As always, it’s a tradeoff between MER, transaction costs and withholding taxes. You have to figure out which strategy works out to the lowest overall cost and then decide if you’re willing to pay a little more convenience.
As for the derivatives in the Altamira US Index Fund (and the hedged version of the RBC US Index Fund also), that I don’t know. Give me some time and I will see whether I can get an answer.
Indeed, still a fair point. Like I said to Leeds though, even if you don’t bother with the Gambit and exchange at regular rates annually, you’re still significantly better off in the long run. You have to rebalance anyway, so there’s really no added effort, no?
Still, I do agree that people should stick to what they understand and are comfortable with. And certainly that if possible they should consider all the various costs you listed and decide on the best tradeoff for them.
Thanks again for the great site BTW. Sorry for monopolizing the comments lately! :)
Thanks, Nathan. Don’t apologize: the comments from knowledgeable investors make the blog much better!
As per out last discussion about synthetic DRIP’s of US$ securities, I have again confirmed with iTrade that there is a currency conversion fee both ways. There is no way around this. I have also learned that <$5000 is a 2% currency conversion fee! That would be 4% total! Their US$ Friendly RRSP program does not extend to dividends.
@nathan: I agree with your tactic of investing in e-series funds and rebalancing within TDW. I am only waiting for TDW to offer some free trades like iTrade did before I move some assets over. I would also like to verify how dividends are handled with synthetic DRIP's of US$ securities with TDW before moving though.
More confused now. I received some of my US$ dividends and calculated what I lost in the currency conversion fee. I used a rate of 1.0167 as spot rate. When I calculate it out the currency conversion fee was 0.97%
I was expecting a 2% conversion fee as discussed with an iTrade rep just yesterday.
Great post, CCP — always useful and informative read!
I want to treat my nonregistered, TFSA, and RRSP as one large portfolio. Based on the ‘Foreign Withholding Tax Explained’ article, it seems most times that international stocks withholding taxes apply but are not recoverable, except when it is non-registered as part of Canadian fund that holds international stocks directly. Would I be better off allocating international index fund (TDB911) to my non-registered account?
Prior to reading these articles, I’ve tried to keep my US and international index funds (e-series funds) in RRSP, bond index (e-series) in both RRSP and TFSA, REITs in TFSA, and Canadian equities (usually dividend paying stocks) in my non-registered. After reading the foreign withholding tax articles, I’m starting to have second thoughts…
@DL: It’s really important to consider all taxes and costs and not just base the decision on withholding taxes. If you put the international stocks in a non-registered account you can recover the withholding tax, but the dividends are fully taxable as income, and the capital gains are also taxable. So it’s a tradeoff. This article will help: http://bit.ly/Vo6oPc
For the purposes of foreign withholding taxes, do RESPs get the same tax treatment as TFSAs?
@B: Good question. Yes, they do: RESPs are not retirement accounts, so the exemptions that apply to RRSPs do not apply here. And you cannot reclaim any withholding tax paid.
@ Nathan
Took the plunge and did my first Norbert’s Gambit through TDW. I am feeling a little mathematically challenged right now and am having trouble figuring out the actual rate at which I converted. My confusion stems from the fact that the transactions initially show up in Webroker (and the mailed transaction confirmations) as if automatic wash trading did NOT occur (forex fees ARE deducted) and then everything seems to come out in the wash (pun intended) 3 days later (today) with the purchase of the correct amount of TDB166. Could you explain to me how I figure out the rate I actually received?
Hmm.. I personally do all my gambits in taxable accounts (since my RRSP is small and just holds fixed income). However, assuming the washing was done correctly, a foolproof way should be to look at the prices paid on the stock you used to do the gambit. The price listed on the Canadian buy should be in CAD, and the price for the US sell in USD. (Unlike the total amounts, which I believe will all be listed in CAD.) You’ll also want to take into account the commissions, so here’s what I would do:
(Pc * n + C) / (Pu * n – C) = CAD/USD
Where Pc is the price per share paid on the Canadian side, Pu is the price per share received on the US side, n is the total number of shares purchased, and C is the commission paid (generally $9.99).
To double-check the washing part, the USD you got from the gambit, (Pu*n-C), should be equal to the USD value of your TDB166, which you can get in the same way, by multiplying its purchase price per share by the number of shares owned.
Finally, you can look at the conversion rate calculated above and compare it to the high and low on the day you did the trades by looking here: http://www.bankofcanada.ca/rates/exchange/10-year-lookup/
(Keeping in mind that it might be slightly lower due to the spread and commissions paid.)
Somebody please correct me if I’ve made a mistake. (Or if there’s an easier way to get the numbers that I’m not thinking of.)
@ Nathan
Awesome! Thanks! The equation seems to work – came out as .9822 (within the daily range). I was getting confused because (being the impatient guy that I am) I immediately bought VXUS with some of the proceeds of the USD Potash sale. When things settled today it didn’t show the purchase of TDB166 and its subsequent sale to buy the VXUS – it only showed the purchase of TDB166 with the cash that was left over after the purchase of VXUS.
Awesome! Isn’t exchanging currency for (almost) free fun? :)
Noticed a slight mistake in what I said – the calculated amount might come out slightly *higher* than the day’s range, not lower, since we’re calculating 1 USD = X CAD. You’re going from CAD to USD, so lower is better. ie: you want to pay fewer CAD for each 1 USD you buy. (Always find those require a bit of thought, especially when the exchange rate is near 1…)
Anyway, in your case it doesn’t matter since it sounds like you ended up with a great rate.
I just received my first distributions from XHD.TO and was expecting to be dinged 15% for withholding taxes. Do the Ishares distributions already have the tax taken out prior to sending to holders?
@CK: Yes, the withholding tax is subtracted before the distribution is paid to investors.
I agree with Nathan that exchanging currency for (almost) free is a hoot.
Similarly, I only do it in my non-registered accounts.
This article points out how doing it in a TDWH RRSP, something I haven’t done, is even easier: http://www.canadiancapitalist.com/easy-norbert-gambit-in-td-waterhouse-rrsp-accounts/
I’m in the middle of moving everything to RBC Direct Investing and passive/index investing. Have several LIRA and RRSP accounts I have to treat separately, so this week did my first two “Norbert’s Gambit” trades. A bit nerve racking but worked out well, saving a couple hundred dollars in one exchange and close to a thousand in the other.
Couple things I noticed – first, just because you qualify for the $9.95 trade commission rate at RBC doesn’t mean you automatically get it. They continue to charge the full commission until you request the preferred rate – they then verify and set it. They will credit you for the excess commission on the previous trades, but still a hassle. Second, while it can be a bit nerve racking to a first timer seeing the CAD and USD sides of the account sitting at + and – for a few days until it settles out, you can actually see in the “Activity” list on your RBC account that they auto journalled over the CAD shares when you sold them on the US side, the description of the shares sold on the US market show as “CANADIAN LISTED CA JNL”. Well, I’m assuming the “JNL” means “journal”, since that JNL does not show up on any of my other sales.
@Nathan
Going back to our earlier converstation about double conversion charges at TDW for synthetic US$ DRIPs. Read this article.
http://www.canadiancapitalist.com/double-dipping-on-currency-conversions-in-us-dollar-rrsp-drips/
Thanks Joe. So indeed, until TD releases their planned USD RRSP, DRIPs should not be enabled for USD ETFs. (Instead, they can simply be reinvested along with one’s regular contributions.)
The article states 2K is the break even point but that assumes a 1.5% conversion fee into canadian dollars (which can be higher) and using norbert gambit (assumes $9.99 a trade) to buy back US$ and a third trade (again $9.99) to buy back the US$ security. It does not take into consideration the bid ask spread which will be minimal if you buy an expensive stock with high trade volume.
This is also assuming you are buying only one US$ security.
IMO……..I will stick with the synthetic drips until TDW or iTrade offers a US$ RRSP. Even if I had 2K in US$ dividends it is far too tedious to buy back the same security going through that entire process compared to the synthetic DRIP.
Someone posted that iTrade actually does not do the double fx fees but I have my doubts. I will activate the DRIP on some of my US$ securities and see for myself what iTrade does.
On last months dividends they charged less than 1% fx fees to convert to CDN so who knows!
That makes sense to me if you only make one contribution for the year. If you’re making regular contributions though, it would appear to make more sense to roll the dividend proceeds into your next regular contribution.
Or, even if you do only contribute once a year, as long as you’re making more than $100 a pop in dividends, put them in e-funds throughout the year, then sell the e-funds once a year and include the proceeds in your annual contribution. Of course, the convenience factor may be worth it to not do this, depending on the size of your portfolio.
In my taxable accounts I am setting up a passive portfolio. I wish to maintain small cap exposure. However, VBR (US Small Cap Value) has a 30.2% turnover and VSS (Non-US Small Cap) has a 37% turnover. My asset allocation does not leave sufficient room in tax advantaged accounts for these ETF’s. Should I forgo small cap exposure in the taxable accounts?
@Al: Just because an ETF has relatively high turnover does not necessarily mean there will be significant capital gains. The ETF structure allows the fund manager more flexibility than with traditional mutual funds. So before yu make your decision, check the fund’s literature to see if there were significant capital gains distributions over the last couple of years.
@Al: Total market funds like VTI offer a small cap exposure with low turn over. DFA “core” funds offer a higher small cap tilt with low turn over but you need to pay a commission to the advisor…
Generally, in taxable accounts it is more tax efficient to use a “core” approach than to separate small caps vs large caps funds.
I have a company account with some ETFs invested… Are the tax issues same for this type of account?
@paul,
Not exactly, no. For one thing, (assuming the company is a CCPC) ‘recoverable’ withholding taxes are effectively only about 25% recoverable, because the RDTOH is reduced when claiming a foreign tax credit. It still acts as a non-registered account as far as which options are better above, but in all cases you’ll end up paying more withholding tax.
Another difference with corporate accounts is that depending on your overall situation, tax loss harvesting may actually not be beneficial; in fact, it may make sense to harvest capital gains.
There’s a ton of info for investing in CCPCs in this thread at the Financial Webring Forum: http://www.financialwebring.org/forum/viewtopic.php?f=32&t=104316
Where does the new vanguard VFV fit into this table?
So, you want to see a mess . . . I did a norbert’s gambit using POT. Unknown to me, I did the CAD buy / US sale on the ex dividend day for POT. That shouldn’t have been an issue, but RBC Direct Investing incorrectly paid out dividends to the US side of my account based on the shares I briefly held that day. They noticed the error, and immediately debited my account to correct the error. Except they debited my CAD side, compounding the error. Once they realized that error, they credited the CAD side and debited the US side to fix the two errors. Unfortunately, in the time it took that to settle out, the incorrect dividends had sat on the US side long enough to cause a DRIP, so once they’d corrected all their credit/debits, my account was now sitting negative with a bunch of POT shares I didn’t want. They are now working on “undoing” that trade and crediting the amount back to my account, hopefully this is the end of it. They’ve credited me the commission of my last 5 trades as a goodwill gesture which is nice, but the whole thing has been quite the annoyance.
@Slacker: VFV is in category D: a Canadian ETF that holds a US-listed ETF of US stocks.
@HMS: Ugh, what a nightmare. The only suggestion I’d make is to use DLR for Norbert’s gambit rather than a stock.
Problem with DLR (last time I checked anyway), it wasn’t fully automated at RBC like using POT or RBC is. For some reason their system doesn’t handle DLR and DLR.U automatically and requires a phone call.
@HMS – I work with RBC Direct Investing with many of our DIY investors, and the process for changing CAD to USD using DLR and DLR.U is completely seamless (it doesn’t require any phone calls and each step can be done immediately after one another). I’ve outlined the process below using an example of 1,000 shares of DLR and DLR.U (purchasing VTI with the US dollars):
Step 1: Buy 1,000 shares of DLR (Canadian market) in your CAD account at the current ask price (use a limit order)
Step 2: Sell 1,000 shares of DLR.U (Canadian market) in your USD account at the current bid price (use a limit order)
Step 3: Buy approx. 140 shares of VTI (US market) in your USD account (use a limit order)
I’ll have to give that a try next time. Last time I tried to do anything with DLR.U, I got a message on the screen saying I needed to call them to do any trades with that fund.
Is there an error on the recommendation for International Equities held in RRSPs (i.e. choose A or C and avoid E)? According to the connected Moneysense blog, A, C and E all have withholding taxes applying and not recoverable . At least it seems to say that. the actual words are: “In an RRSP or TFSA, US and withholding taxes apply are not recoverable.” That would make them all equally bad with no option to avoid these taxes in an RRSP.
Bottom line question: am I better with VXUS or TD’s International fund in an RSP (from a withholding tax perspective) or is it irrrelevant?
While I’m asking, please confirm that the TD fund is preferable to VXUS in a taxable account.
Thanks!
@Brian: The advice was correct, but it was unclear because there was a missing word in the phrase you quoted. For fund type E, it should have said, “In an RRSP or TFSA, US and international withholding taxes apply are not recoverable.” I’ve corrected it.
The key idea here is that there are two levels of withholding tax when you have a US-listed ETF that holds international stocks. First the overseas companies withhold tax before dividends go into the fund, and then the IRS withholds tax before the dividends are paid to Canadian investors. So if you hold type A or C in a registered account, you only pay international withholding taxes. But if you you use a type E fund in an RRSP, you pay both levels of tax.
In the case of VXUS versus the TD International Index, the tax is the same.
Since I don’t have much money invested and I’m new in investment, all my money is in ING. At ING, we can only buy portfolio with predetermined equity/bonds index ratio.
However, by combining the equity growth portfolio with others, I still can achieve 60/40 ratio, but with a higher canadian equity. Would that be more tax-efficient?
@bettrave: Yes, a higher allocation to Canadian equities would be more tax efficient, but less well diversified. On a small portfolio, however, this is not likely to be a hugely important decision.
What is the most tax efficient way to invest in emerging markets if I don’t have any contribution room left in my RRSP?
@Dave: You’ll likely find that a taxable account is best, since you can recover a portion of the withholding taxes. Emerging markets ETFs tend to have fairly low yields, so most of the growth comes in the form of tax-efficient capital gains.
This is probably a dumb question but where are the A,B,C,D’s and E’s in the chart?
Even my wife who is much smarter than me can’t see them.
Thanks,
Jerry
@Jerry,
I was also confused initially. The letters refer to the bolded section in the 2nd paragraph of the article (above the tables)
Can you recommend a tax efficient bond fund etf for my rrsp? It seems that most are so low yield right now that they are not worth it. There are high yield funds like ZEF and the RBC high yield mutual fund that are interesting , but I don’t know how suitable they are given the withholding taxes. Are there any Canadian listed high yield bond etfs that you would recommend?
Thank you
@Ben: There are no withholding tax issues on bonds, so if the fund is in your RRSP you don’t have to worry about tax efficiency. Personally I don’t recommend high-yield bonds. I share this school of thought:
https://canadiancouchpotato.com/2010/10/04/high-yield-bonds-and-your-portfolio-part-1/
@Ben:
The purpose of bonds in a couch potato portfolio is to reduce overall volatility (risk). High yield funds take on additional risk to get that yield, so largely defeat the purpose. If you are comfortable with taking on more risk, you are almost certainly better off changing your asset allocation to include more equities and less bonds, rather than looking for high yield bond funds.
More likely though, your asset allocation is correct, but you’re disappointed with the sub-2% yields offered by government and high-grade corporate bonds these days. The solution to low yields isn’t to take on more risk though, IMO. Unfortunately there isn’t really a great solution besides saving more. That said, what I would recommend for fixed income in an RRSP are GICs. You can build a 5 year GIC ladder paying around 2 to 2.5% average, with no fees, no credit risk and very little interest rate risk. Beats any bond fund out there. The only downside is that the money is tied up in the GICs, but for RRSP investments that shouldn’t be a problem.
Even before that though, are the rates you can get in TFSAs. The best deal in safe fixed income right now is the 3% cash TFSAs offered by People’s Trust and Canadian Direct financial. Until 100% of your TFSA contribution room is in one of those, I personally don’t see any reason to look at other fixed income options, which would pay less and include some amount of interest rate risk. You would have to be in a very unique tax position for the differences between RRSP and TFSA taxation to outweigh this advantage.
@couch potato
@ nathan
thanks for your very quick response to this question. I am clearly not as knowledgeable as most of your commentators and so I am usually mystified when it comes to the bond market. In any case, if you still recommend sticking with the safe bond etf solution (I am not too hot on GIC laddering, but thanks for the suggestion), then would you recommend parking the bond portion in my portfolio (about 30-40%) in XBB/VAB or short-term bond etfs like XSB/VSB. Can you tell me the difference in terms of portfolio strategy in terms of choosing short-term bond etfs.
Thank you again for your help.
@Ben
with bonds, the price will drop as interest rates rise. Anyone looking to buy bonds will buy the newly issued ones with higher yields rather than the bonds in your ETF which will have the current yield which will be lower than new bonds once rates rise. Your bonds will have to sell for a discount, to compensate buyers for the fact that they could get higher yields by purchasing newly issued bonds- so you can lose money holding bonds in an ETF as the unit price will drop as interest rates rise. this is why some people prefer GICs as their face value never falls.
XBB/VAB/ZAG all have longer durations, so their unit price will fall faster when rates rise. XSB/VSB have shorter duration bonds so they will not fall as much as one can sell them as they mature in 2 to 3 years, and replace them with with newly issued higher yielding bonds. For XSB etc, it may take 5 to 7 years for the bond to mature. Since many people expect interest rates to rise, you may wish to go with VSB, however if you are a true believer couch potato, that may be considered market timing, so you should stick to ZAG etc. Perhaps a 50/50 mix would be ideal? Also don’t forget real return bonds that are found in XRB.
Hi All,
I’m very easily confused with investing versus taxation. I currently hold XBB in my TFSA and XBB/XWD/XIC within my RRSP account. This is to maintain the ratios suggested by the Global Model.
What would make things more tax efficient without dealing in US stocks and ETFs with Norbert’s Gambit.
I’m prefer not to rebalance my portfolio, but to only balance with new money. Therefore, Norbert’s Gambit is also no help to me even if I held US equities/etfs
Regards, CD
@CD: I don’t see any obvious way you can make your portfolio more tax-efficient with the funds you are currently using. Given tat your investments are all in TFSAs and RRSPs any tax impact is going to be limited to to foreign withholding taxes within XWD, which is likely to be very small. Keep saving and don’t sweat the small stuff.
@CD: Since your entire TFSA is in XBB, you could consider opening a TFSA account at People’s Trust or Canadian Direct instead. You would go from a net yield of 2% with XBB (average YTM of 2.36% minus 0.3% MER) to a flat 3%. And unlike the bond fund, you have no interest rate risk.
Assuming a $25k TFSA, you end up with an extra $250 a year, essentially for free, and at lower risk.