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) |
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?
@AJ: This blog should answer your question:
https://canadiancouchpotato.com/2015/01/30/the-wrong-way-to-think-about-withholding-taxes/
I am a bit confused ,on your Sep 20, 2012 post ” Foreign withholding tax:which fund goes where “, you suggested for RRSP to choose C (US-listed ETF that holds international stocks – withholding taxes non recoverable).
Could you clarify in term of Tax efficiency investing ?
Thank you
Hi,
This is an old post, so I hope you’re still seeing this (I arrived very late to the “couch potato investment party”).
Anyway, I read in one of the comments that TFSA are considered as registered. However, as far as I know (unless it changed?), RRSP and other registered retirement savings accounts are exempt of the withholding of the taxes on stocks, but TFSA accounts do not enjoy of this privilege.
So… considering that in your article here you separate accounts in 2 groups (non-registered and RRSP), in the context of this article should I consider TFSA accounts in the groups of non-registered? Or in the group of RRSP (in spite of the difference in the tax treatment agreement between Canada and other countries)?
Thanks in advance,
Tito.
@Tito: TFSAs are distinct from both RRSPs and non-registered accounts and the treatment of foreign withholding taxes is different from these to account types. See my more recent blog post on this topic, as well as the accompanying white paper:
https://canadiancouchpotato.com/2016/07/11/foreign-withholding-taxes-revisited/
Dear Dan,
Thank you for sharing your insights without a fee.
What would be the tax implication for Asset Allocation ETFs: VGRO, VBAL etc?
Should one choose one over the other in RRSP / TFSA / RESP accounts?
Best regards,
PD
@PD: Thanks for the comment. The effect of foreign withholding taxes is the same in all three funds, since they have the same holdings, just in different proportions. My colleague Justin Bender estimated the additional costs to be between 0.12% and 0.18%. This should not be a factor in your decision: just focus on which of the three options matches your risk tolerance.
If US-listed ETFs are held in RRSP, are they required to be accounted for on annual Foreign Income Verification Statement? Apologies if the question has been discussed on the forums already!
@siva: No, you do not need to report RRSP holdings on the T1135. This only applies to non-registered accounts.
Hi Dan, thank you so much for this chart, it’s very helpful for us visual learners! :)
Would it be possible to put ‘A, B, C, D, E’ alongside the columns so we can be sure we are referring to the correct row? For example, in the last chart for International equities in an RRSP, it says ‘avoid E’, but there are only four rows, which I assume are A, B, C, D – I could be reading it wrong?
@Frances: The letters refer to the fund types described at the top of the post:
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.
Ah, that makes sense – I was reading the chart incorrectly. Thank you so much Dan!
Hi Dan,
Sorry I’m a bit confused. Where does holding these ETFs fall in your 3 ETF model? Is this more relevant for Justin Bender’s 5 ETF model where he uses ITOT, and IEMG? I noticed those were both not listed in your examples. Do you recommend these two for us/emerging markets or something else?
I was also wondering when Norbert’s gambit and putting $ in my RRSP becomes worth it. I heard I should be transferring at least $5000 and have an RRSP of 50-100k at least before I really start saving money? I’m just starting out and i’ll only have 20k in my RRSP, is it worth it to go through the hassle of doing all this?
@Vic: My model portfolios include Canadian-domiciled ETFs and index mutual funds, which are still relevant when understanding the impact of foreign withholding taxes. Using Us-listed ETFs in an RRSP (as recommended in Justin’s model portfolios) reduces foreign withholding taxes, but at the cost of greater complexity. For a discussion of the “tipping point” after which this might make sense, listen to Justin’s new podcast, which addresses that question. For what’s it’s worth, I think you should be nearing $100K in the RRSP before the case becomes compelling.
https://www.canadianportfoliomanagerblog.com/podcast-1-plain-and-simple-vanguards-asset-allocation-etfs/
Hey Dan, thanks for the reply and for the link. I’ll listen to it!
I also read a bit more into the Canadian equivalent of xaw (xuu, xef, xec) and further confused myself. Is xuu a canadian etf holding us-listed us stocks, xef a canadian etf holding international, and xec a canadian etf holding us-listed international stocks? Meaning withholding taxes are applicable to all 3 of them and not recoverable in my RRSP/TFSA?
I understand why I’d want to use ITOT, IEFA, IEMG but don’t understand why xuu, xef, and xec are recommended instead of xaw since their MER is higher collectively and I’d have to pay the taxes on them as well? I looked online and just the MER of xef is 0.026?
@canadian couch potato
Sorry I meant xec and not xef in my last sentence. Silly question but am I not looking at the MER correctly? I just googled XEC and saw this link https://www.blackrock.com/ca/individual/en/products/251423/ishares-msci-emerging-markets-imi-index-etf and looked at the MER listed there. I think I’m looking at this incorrectly since I read one of your other comments where you wrote that xuu xef, xec have lower product fees (about 0.14% vs. 0.22% for XAW).
@Vic: Holding the individual components of XAW has no effect on foreign withholding taxes in either TFSAs or RRSPs. Using the US-listed ETfs does have a tax advantage in RRSPs (not in TFSAs) but trading Us-listed ETFs involves currency conversion and is significantly more complicated.
As for the MER, remember that XEC is only a small part of XAW. The largest components are XUU and XEF, which have lower MERs than XAW.
what is your latest verdict for RRSP, A beginner and wants less complicated with tax and filing
@NR: If you’re a beginner who wants simplicity, then there’s nothing wrong with holding a one-ETF portfolio in an RRSP and/or a TFSA. Asset location strategies have very limited value for smaller portfolios that consist of tax-sheltered accounts only.