If you live in a big city, you can save a few cents per litre on gas by travelling to the boonies. But you also understand that it doesn’t make sense to burn $10 of fuel driving out of town so you can save $8 on a fill-up. Yet many investors seem to be making a similar error by trying to avoid foreign withholding taxes in their registered portfolios.
About a year ago, Justin Bender and I co-wrote a white paper that estimated the cost of foreign withholding taxes. There are far too many details to review here, but among the most important is that withholding taxes on dividends are lost if you hold a Canadian mutual fund or ETF of foreign stocks inside an RRSP or TFSA. If you hold the same fund in a non-registered account, however, you can recover the withholding taxes by claiming a credit on your tax return.
Sometimes I feel like we created a monster with this paper, because I have received many e-mails from readers who have misunderstood this information and made poor decisions as a result.
Here’s an example: Cyril wants to build a balanced portfolio that includes US and international equities, and he wants to use only Canadian-listed ETFs. Having read our white paper, Cyril knows that if he uses an ETF such as the Vanguard US Total Market (VUN) in an RRSP or TFSA, it will incur a 15% withholding tax on the dividends. So although he has plenty of contribution room in his tax-sheltered accounts, Cyril decides to hold his US equities in a non-registered account so he can recover that withholding tax.
That might sound wise, but it’s like driving a hundred miles out of your way to buy cheaper gas. Cyril’s decision would avoid a small withholding tax on dividends while opening himself up to Canadian income taxes on the fund’s total return.
Save a little, pay a lot
Let’s assume Cyril’s portfolio includes a $10,000 holding in VUN, and that the yield on the fund is 2%. The ETF would pay $200 annually in dividends, resulting in withholding taxes of $30. This would be lost in an RRSP or TFSA, but recoverable in a non-registered account. But you can’t stop there.
If Cyril holds the fund in a non-registered account, he will need to report the full $200 as foreign income and it will be taxed at his full marginal rate. Assuming an average income, his marginal rate is likely about 30%, or more than double the rate of US withholding tax. What’s more, any capital gains on the ETF will eventually be taxable—at half his marginal rate—when they are realized.
All of which is to say, in the vast majority of cases Cyril’s overall tax bill is going to be significantly lower if he holds his US equity fund in a tax-sheltered account. And that doesn’t even factor in the tax deduction Cyril would receive by making a contribution to his RRSP.
Counting the cost
You may have noticed something else in the comparison above. The total impact of foreign withholding tax on Cyril’s $10,000 holding was just $30. When investors hear “you’re subjected to a 15% tax” it can sound dramatic, but in dollar terms it may not be much at all. On a five-figure portfolio, foreign withholding taxes should not be a primary concern.
Consider another young investor, Lana, who has $36,500, enough to max out her TFSA. She’s decided to keep 50% of her portfolio in US and international equities, but she’s worried that foreign withholding taxes will erode her returns. If we assume international equities yield about 3% and the average withholding tax is 10%, it turns out the cost is also about $30 per $10,000 invested, the same as for US equities. So the total impact of foreign withholding taxes on Lana’s TFSA would be about $55 a year. That’s not negligible, but it’s probably a lower number than you expected. And it’s clearly not a reason for Lana to avoid getting global diversification.
So let’s be clear: most investors should take full advantage of tax-sheltered accounts before investing in non-registered accounts, period. While there are exceptions to this rule of thumb, none of them have anything to do with avoiding foreign withholding taxes.
Bang on. Individual circumstances always vary, but I find the best/easiest rules of thumb to be:
TFSA is almost always a better choice than Unregistered accts (for the reasons you cite above). Besides very “advanced” circumstances, almost no reason why a “regular investor” would choose to fill an Unregistered acct before TFSA.
Whether RRSP > TFSA or visa versa depends almost entirely on your current and future marginal tax rate. If you think or have reasonable guess that your future tax rate will be higher, RRSP is a bad idea. If the opposite, it’s a very good idea. Sadly, there’s really no way to be certain on this. On one hand, if saving for retirement, you might expect that your rate would be lower (coupled with some flexibility to time withdrawals, etc). On the other hand, the govt could run short and increase rates at any time in the next 30yrs… nobody knows.
Couldn’t agree more with your last couple of lines Dan.
“…most investors should take full advantage of tax-sheltered accounts before investing in non-registered accounts, period. While there are exceptions to this rule of thumb, none of them have anything to do with avoiding foreign withholding taxes.”
Through experience and reading various articles, including your stellar white paper mentioned above, I’ve learned to max out the registered accounts with CDN, U.S. and international equities first. That’s priority #1. If and when that is done, then I can focus on the non-registered account and in my case, I tend to hold CDN dividend paying stocks there. I might eventually hold a tax-friendly ETF like XIU there as well.
Thanks for the great reading material on withholding taxes from you and Justin, the concepts are tricky.
Mark
@CCP, if someone is young in their career, not in the highest tax bracket, but can confidently predict their income will soon (5 years) be in the top tax bracket based on pay structure, is it worth deferring RRSP contributions until the highest tax bracket is met? Not only will they be able to top up their TFSA in the short term, and contribute to international holdings in a taxable account to save on withholding taxes, they will maximize the tax deferral of the RRSP. Your thoughts are appreciated.
With a 2% GIC and and say VXC yielding 2% (both $10 000), only $10 000 room in TFSA, no room in RRSP, would it then make sense to hold the VXC in non registered?
Consider that I plan to buy and hold ETFs long term. The GIC is a portion of emergency fund and also provide wiggle room for rebalancing my VCN in the TFSA each year. I can reallocate the cash wherever without incurring commission cost.
I agree with what you’re saying here when it applies to a five figure portfolio. However, once an account hits, say $300,000, is it time then to restructure things to minimize the withholding tax?
I think the key thing to keep in mind, for just about any advice we get on here, is “analyze all variables”, if you just think “must avoid withholding taxes…” the same way that Homer Simpson thinks “Yum, donuts”, then you’ll get into trouble.
But Dan, don’t think that article only had negative outcomes: for example, I’m able to minimize withholding taxes because I’ve got my US holdings in my RRSP and International in TFSA.
@Kirk: I think you should see an accountant for that type of advice.
I tried to understand that Withholding Taxes Paper. Was wayyy to complicated for me. Read the bit at the end and just assumed that 15% is probably equivalent to a MER of 0.3%.
My conflict with RRSP/TFSA vs non-reg account is…
From my understanding, RRSP+TFSA is best for fully taxable stuff like GIC/Bonds/Savings accounts so I’m actively trying to not put equities in those registered accounts.
So in the end, shouldnt equities be in non-registered account anyways?
@Kirk: You can make the contribution now so that the international holdings grow tax free. You don’t have to claim the deduction in the same year that you make the contribution (i.e., you can defer the deduction until it will make a bigger difference in reducing your income tax). But like Paul G said, you might want to see an accountant for specific advice on deduction timing.
See here: http://business.financialpost.com/2013/02/22/the-difference-between-an-rrsp-contribution-and-deduction/
@Kirk
You could make the contributions but defer the deductions until you’re in the top bracket; thus the contributions are growing tax free during that time. Additionally, should you find that in 5 years you are out of a job for some reason and thus not able to make use of the deferred deductions, I believe you could file amendments to the previous returns to take the deductions for those previous tax years (subject to a time limit [8 years?]).
Having TFSA room complicates things and it may be best to just max that out instead. However, knowing what the options are is always a good thing.
My 2 cents.
Arrrg, didn’t see Adam’s post until I had posted mine.
@Alice, @CharlieF
You may want to rethink the idea of allocating assets that pay interest (GIC/Bonds) to registered accounts. Even though the interest is typically subject to higher tax rates than the dividends/capital gains you get from stocks, these investments will nevertheless likely attract lower total tax because the returns are much lower than the expected returns on stocks. Therefore, you will likely pay less total tax by putting stocks in your registered accounts and bonds/gics in taxable accounts.
@Steve: With a larger portfolio, the numbers from above would only grow proportionally. Say you’ve got a VUN holding of $100,000, you’d just have $300 of withholding taxes but $2,000 of potentially taxable income, plus also taxable capital gains that are tenfold compared to Dan’s example. The size of the portfolio therefore doesn’t change the fact that a tax-sheltered account is still preferable to a taxable account.
The difference with a lot of money is that you might have run out of contribution room. In that case, it’s time to look at Dan’s “Put your assets in their place” article, where withholding taxes are one of several considerations.
Returns in a taxable account are always going to be worse than in a sheltered one. By deciding where to put which assets, it’s possible to minimise how much worse it is. It’s still going to be worse though.
Here’s a simple rule of thumb to minimize the effect of withholding taxes:
TFSA – Hold Canadian investments
RRSP – US situs funds or stocks. No withholding taxes per the treaty.
Cash Account – ex-North America, via ADRs or Canadian situs funds that hold the underlying international securities directly, not via a fund of funds model.
@Kirk: As Adam points out in his comment below, it is not necessary to use a non-registered account if you have RRSP room and simply want to defer the tax deduction.
@Steve: It definitely makes sense to think about withholding taxes at $300K. In terms of restructuring things, however, it depends what that means. If you are able to hold all $300K in tax-sheltered accounts it likely makes sense to do so. But it’s worth considering US-listed ETFs in the RRSP, assuming you are comfortable doing Norbert’s gambit.
@Paul G: Thanks for the comment. Although the paper has been misinterpreted by some, it has been very influential among advisors and ETF providers. Justin has fielded a lot of inquires about it. The issue is not new, but his calculations took things a step further than anyone else, and it got noticed by the right people.
@CharlieF: It depends on your situation. If you have room in registered accounts, again, all long-term investments are probably best held there. If you need to hold some money in a non-registered account, you can make a pretty good argument for using it to hold a savings account that generates almost zero taxable interest these days. I wish there were hard and fast rules for asset location, but unfortunately it’s not so simple.
I do believe that many investors are getting sucked into hyperoptimization of their porfolios at their detriment. I applaud you trying to clean this up by taking on this withholding tax issue and people chasing low MERs.
If you are a couch potato with this allocated reasonably you’re 95% of the way there.
HI Dan: thanks for that great advise on using tax sheltered accts first. I have $31K room in my TFSA and also hold Mawer Global Sm Cap fund of $31K in my cash account. I think this is the right time for me to transfer it to my TFSA as any capital gains I have up to now, only becomes payable in April 2016!…
thanks for the CCP blog.
Best,
Prasanna
Maple.
@CCP: If ever you do another go-around on that paper, may I suggest you change the wording when looking at “recoverable” withholding taxes in taxable accounts ? Recoverable will mean, to a lot of people, being able to get them back, whereas what it really meant was that you could get them credited against Canadian taxes and as such not pay them twice.
(feel free to remove this from the blog’s comments since it’s a comment really meant for you alone…)
On a lighter note, and for those that think visually … my father used to tell me “don’t let the tail wag the dog”. An odd quote perhaps but, for context, he was a seasoned tax accountant. This was his way of advocating that the tax reason (the ‘tail’) for a given transaction should not outweigh the commercial/other reasons (the ‘dog’) for that transaction. I suspect that he’d rather approve of the above posting :)
@CCP or anyone with some advice,
I have some questions that are related to foreign investments but not withholding taxes directly. I have non-registered investments in US listed ETFs that I am thinking about selling. Ultimately I would like to put them into my TFSA but that money was invested from an investment loan. So to sell the ETFs I would pay capital gains and pay back the loan. All remaining would then go to the TFSA. I’m not sure how to do the cost/benefit and run the numbers. There are a bunch of things at play:
– US ETF money needs to be sold and converted to Canadian dollars to pay back the loan (using NB).
– US ETF money not being used to pay back the loan can be put into US$ TFSA account.
– I would have to pay a sizable capital gains tax
This all seems complicated so I’ve just been leaving the money invested and paying the interest only payments on the loan. I’m worried that if I cash it out I’ll have to pay so much in capital gains and not come out ahead. Perhaps in the long run I wouldn’t have to pay any taxes on the TFSA but I have less money invested to grow. Thoughts?
@SterlingF
When selling a US ETF you will pay gains on the Canadian dollar gain – Canadian dollars received for the ETF sale minus Canadian dollars paid for the ETF. This necessitates converting US dollars to Canadian dollars for both purchases and sales. You are allowed to use either the yearly average exchange rate or the exchange rate on the day of sale or purchase – however, you can’t mix and match; you must be consistent. Since it’s not possible to know the 2015 year average exchange rate at this time you can’t run the calculations that way, and must use exchange rate on the day of purchase/sale. This is somewhat more of a PITA than using yearly average rates, but isn’t rocket science.
The fact that some of the US money from that sale may not be explicitly converted to Canadian dollars (because it’s going into the US dollar TFSA account) is irrelevant AFAIK. It still must be converted on paper to determine your gain from the sale.
So, run the numbers using the exchange rate on the day(s) of purchase and the most recent daily exchange rate and see what happens. Note that come time to pay 2015 taxes you could run the numbers again using yearly averages exchange rates and see if that works out more favourably.
The Bank of Canada website has yearly and daily exchange rates.
Disclaimer: I am not an accountant and this is my understanding of the issue. If I’m incorrect in some way, hearing so would be beneficial.
@Jim R:
Thanks for that. So if I’m understanding your correctly, I need to calculate the Canadian dollar net gain on the US ETFs to determine what my capital gains tax would be. It would be deemed a disposition of funds in Canadian dollars whether I actually converted it to CAN$ or not. So once I do that calculation I would know how much I need to pay in taxes to be ready for it. Then I should be able to know the amount of money left invested to appreciate tax free in my TFSA and see how many years until my break-even point. Hopefully that made sense.
@SterlingF
Right, that’s what I tried to say.
However, I have to reiterate: I am not an accountant. So getting confirmation from someone else would be good.
@Jim R – absolutely. I’m going to look into this more but the day of purchase/day of sale exchange rate thing was something I hadn’t considered before.
Another great article! I’ve had a few discussions (arguments) where people are asking for advice on forums about where to put what and they become overwhelmed by the info. Then I learn they haven’t even setup their investment accounts yet and have years worth of TFSA and RRSP room to fill. But they want to have three accounts set to be “100% tax efficient” on Day 1. Talk about putting the proverbial cart before the horse! Months later I’ll find out they still haven’t set anything up because they were getting too many conflicting viewpoints. Ersh… After that timespan they’re usually kicking themselves for losing out on gains and asking for advice again. Paralysis by analysis, totally. My advice is generally: “Get things going right now in your tax shelters! Diversify your indexes and worry about the tax stuff later when you have a bigger chunk of change.” I’ve been doing CCP for almost 3 years now and finally rearranged everything to be far more tax efficient last month. I can’t begin to fathom the losses I would have had if I procrastinated and obsessed about taxes.
@Edward: So refreshing to hear your comments: your advice to others is dead-on. Obviously you shouldn’t rush headlong into an ill-conceived investment plan. But neither should you procrastinate for months until you understand every nuance. As Preet Banerjee likes to say, take the easy A-minus.
Thanks as usual for all the tips. This makes lots of sense. I have a question related to bonds. I know it makes most sense to hold bonds in tax sheltered vehicles. Mine is more a question of types of bonds. I read a lot of ppl recommending short term bonds for when interests eventually start to climb. That being said, they have moved yet and the yields are much lower. Also in a few years when rates are higher, does it not make more sense to switch to long term bonds then to potentially prepare for the next future recession and interest rate cuts. My head is spinning with all these potential ideas. I try to stick with the couch potato strategy as much as possible but this one seems a little more predictable? I almost feel the same when the dollar has tanked so much that maybe its a good time to buy hedged etf’s if our dollar tanks into low 70 or high 60 cent range……just looking for some comments. This has been distracting me for quite some time…thx
@Bruce: These questions have been distracting most investors for some time. :) You say “in a few years when rates are higher,” but there is no reason to assume rates will be higher in a few years. People have been saying that since 2009 and rates continue to fall. The decision to use short-term bonds versus longer-term bonds should not be based in guessing where rates will go. It should be made on your stomach for volatility (short-term bonds are more stable) and your time horizon.
https://canadiancouchpotato.com/2011/07/07/holding-your-bond-fund-for-the-duration/
As for buying hedged ETFs when the dollar is low, that’s the topic of tomorrow’s blog.
The biggest danger here is analysis paralysis. If you honestly can’t resolve these distractions I would suggest using intermediate-term bonds and hedging half of your currency exposure. Better to be half right than out of the market.
I spent too much time last year agonizing over XSP vs XUS. In the end, I went 50/50 and haven’t looked back.
Hi, I am a college student and is not earning an income i.e. I am in the lowest tax bracket as I do not make over $9900/annual.
I am planning on implementing the coach potato strategy and realized that foreign equities have withholding taxes that cannot be recovered under a TFSA account, however can be claimed with a form in non-registered accounts.
Assuming my capital gains / dividends / interest accumulated does not exceed a certain threshold i.e. $9900 annual.
My question is whether it would actually more beneficial in my circumstances to actually implement the strategy in a non-registered account and apply for tax claims back based on my annual “income” level?
@Joey L: I suppose it can make sense to use a non-registered account instead of a TFSA if you don’t pay tax anyway. But I’m not sure what you mean by your last sentence.
Thanks for the hasty reply!
I’ve been reading your blog now for over a period of time, and noticed that you mentioned that foreign funds (TDB902 and 911 via the E series portfolio) gets an unrecoverable withholding tax that cannot be claimed back if implemented in both RRSP and TFSA, if i remember correctly :P
Since i don’t pay tax anyway, I was wondering if it would make more sense to invest in a non registered account (at least for now until i start paying tax), as I “would” also be able to claim back specifically *foreign withholding taxes* as well as dividend/interest income taxes? Is this assumption correct?
Thanks, once again! :)
@Joey L: No, sorry, that won’t work. The foreign tax credit is non-refundable, which means it can be used to reduce the amount of tax you would otherwise pay, but if no tax is payable it will not get you a refund.
I think this might fall into the category of “foreign withholding taxes are not worth worrying about.”
@Joey: an advantage of registered accounts is also simplicity: you don’t have to worry about declaring anything, capital gains or losses or whatnot. Just that simplicity makes it worth always using registered accounts when you have the room.
@ Bruce, looking at your post I could be reading my own thoughts about fixed income. LOL. I actually found the decision on bonds very difficult.
I ended up keeping all fixed income in my RRSP and LIRA, a lot of it in 5 year GIC ladders. I did a calculation based on if there was a bear market (market drop x%) how much liquid fixed income might I need to sell to re-balance my portfolio. I keep that much in ETFs and the rest in GICs.
Based on my projected retirement timing I was uncomfortable with the duration of VAB so I went with a mix of VAB and VSC that keeps my average duration around 5 years and the corporate bonds in VSC bump the yield up a bit, hopefully with minimal extra risk since there is nothing in VSC with lower than BBB credit rating. When it comes time to make more contributions I will buy one or both funds to keep my duration on target.
@CCP the white paper is great. I am fairly analytical so I have several pages of hand written notes for my own investments. I made a list of Vanguard US & Canada and iShares US and Canada funds for each asset class (S&P500, Broad US market, EAFE, Emerging markets etc) and the number of holdings and MER for each. Then for each of the funds I hold I made a list of whether FWT L1 & L2 applies to my own funds in each account, and what US domiciled funds could be used to get lower overall cost. Then I calculated how much I could save using US funds, but overall it was only 0.1% of my total portfolio, or about $100 per year per $100k invested. At this time I decided to only hold Cdn domiciled funds, but something to reconsider in the future. It was an interesting exercise, and I suppose there are worse hobbies.
After reading all the CCP posts, I should be able to anwser this, but still hesitating. I’ve sold all my stocks and now ready to invest CCP-style : All stock ETFs, 1/3 canadian and 2/3 international (I’m 37). All my money (and wife’s) is in registered accounts; both RRSPs and TFSAs are full. I already have a lot of cash in US$ (and wouldn’t mind doing a Norbert) so I would prefer holding ETFs in the currency that will cost me the lowest MERs and taxes. So my question is : should I aim to buy all international ETFs in US$ and all canadian ETFs in CA$, and hold as much canadian ETFs as I can in my TFSAs to maximize international ETFs in my RRSPs?
@CCP: thank you for confirming this “general rule”. As for RRSP/TFSA allocation, I keep it simple by making sure both RRSPs are full, than TFSAs and adding incrementally to both RESPs to reach 35K$ for each kid when they reach 18. I would then personally put any extra money on paying down the morgage instead of investing in a cash account.
@John Rock: In general, if you already have USD cash it probably does make sense to use US-listed ETFs for any US or international equities, and to hold these in your RRSP rather than a TFSA if one or both accounts are maxed out. But again, don’t make the initial TFSA v. RRSP decision based on foreign withholding taxes.
Thanks for all these very helpful articles! I have been following your work for a couple years now and have a typical couch potato strategy and allocation: all etfs with about 30% each in Canadian, US, and International, and 10% in a bond etf. I’m 33 and have maxed out my TFSA and RRSP. My concern is that I have all my Canadian in my TFSA and all my US and international in my RRSP, mostly because I thought this was the most tax efficient way to hold these funds. However, I’m concerned that if I ever need to access this money, I would likely need to take this money out of my TFSA, and therefore Canadian funds. So even though I am well diversified, my accessible funds are all Canadian and I am worried that if the Canadian market is down at the time, I could be vulnerable to poor returns or losses.
So, my question: should I be holding US or international ETFs in my TFSA so that my accessible funds are more diversified, despite the withholding taxes that I would incur?
Thank you in advance!
@Steve: Thanks for the comment. I think you’re asking the wrong question. The issue here is that you’ve invested money in in equities even though you’re considering withdrawing it in the near term. Equities are a long-term investment only. If there is any possibility that you will need to liquidate part of your investment portfolio to meet short-term needs then you need to keep a portion in something much less volatile, such as short-term bonds. Your 10% allocation to bonds may not be enough if liquidity is an issue.
That said, if you do have a balanced portfolio of both bonds and equities, and you think there is a possibility that you will need to liquidate part of it for short-term needs, then it can make sense to keep the bonds in the TFSA so you would be able to dip into them without tax consequences.
Thank you for you excellent articles! I’m considering whether to use international bond ETFs to diversify my fixed income investments. Vanguard is making the case for VBU (Vanguard U.S. Aggregate Bond Index ETF (CAD-hedged)) and VBG (Vanguard Global ex-U.S. Aggregate Bond Index ETF (CAD-hedged)). Both invest in U.S.-domiciled ETFs.
Would there be a cost of lost withholding taxes if those ETF’s where held in taxable or corporate accounts?
Would that cost be avoided if I invested in the US-ETFs held by their Canadian counterparts (BND or BNDX)? Is there any quantification of the lost FWT effect, if any?
Thanks!
@Sergio: There is no withholding tax on bond interest: only dividends. Here are my thoughts on adding US and international bonds:
https://canadiancouchpotato.com/2012/03/01/ask-the-spud-should-i-hold-us-bonds/
https://canadiancouchpotato.com/2014/08/29/ask-the-spud-should-i-use-global-bonds/
I’m new to this, and I feel like I’m drinking from the firehose trying to take it all in.
Speaking specifically about RRSPs..
I know (for now) that I want my exposure to US equities to come in the form of an index ETF that tracks the S&P 500.
I gather I have three choices:
1) Canadian-listed ETF that’s unhedged (ex. VFV)
2) Canadian-listed ETF, hedged (ex. VSP)
3) US-listed ETF (ex. VOO)
I gather as well that VOO only really makes sense if you use Norbert’s Gambit to convert to USD at (or close to) the spot rate.
And I gather as well that if I want to protect against foreign exchange risk by hedging, VSP (or a similar ETF) is my only option.
Where I’m unclear is how would VFV compare with VOO? My understanding is the costs involved are as follows:
1) MER – The Canadian listed VFV has a slightly higher MER.
2) Currency exchange costs – Buying VOO means I’d need to buy US dollars first.
3) Withholding taxes – I’d be charged 15% withholding tax from VFV, but not from VOO.
Am I looking at this the right way? Or am I totally off-base?
@Adam: Actually you’re right on in weighing the tradeoffs. Pretty impressive if you’re new to this. :)
@Adam: great question! With Dan’s confirmation to your anaylsis, will you still proceed with VSP? I am still trying to understand the best game plan before switching my high MER portfolio to indexing/ETFs.
Hello,
I would to thank you for all the articles you have been posting. I find them very educational as I’m pretty new to index funds.
I`m still confused with the concept of tax & TFSA even if I`ve seen a couple of post about it in the site. I decided to write to you to see if you could please explain it to me through this example:
Let`s assume that I have $8250 dollars to invest during 2015. I will put $5500 in the TSFA & the rest, $2750, in a non-registered account. For the sake of simplicity, I won`t consider the RRSP for this example. All the money will be invested in the following 3 mutual funds offered by RBC (or any Canadian bank) and the idea is to hold them for the long term for at least 8 years or more:
US Index currency neutral = $2750
Canadian Index = $2750
International Index currency neutral = $2750
Total invested: $8250 as stated above.
Question 1: Shouldn`t it be wise to keep both the International Index & the US Index mutual funds inside the TFSA so they won`t get taxed at all? In other words, shouldn`t the average investor use the TFSA to invest in foreign mutual funds (offered by RBC or any Canadian bank) as the investment grows tax free, plus it won`t have to pay capital gain when he/she sells it?
Question 2: Once you maxed out your TFSA, wouldn`t it be better to keep the Canadian Index mutual fund in the non-registered account as it won`t get taxed as much as a foreign investment? Plus, I will get the dividend tax credit.
Question 3: Given the US Index mutual fund & the US index neutral currency mutual fund, which one should be a better choice, tax wise?
Regards
@Gus: Thnaks for the comment. Questions 1 and 2 are really about the same issue. Yes, if you run out of TFSA room it usually sense to keep the Canadian equities in the taxable account to take advantage of the dividend tax credit. You will be subject to foreign withholding tax on the dividends paid by the US and international funds in the TFSA, but the impact of these is less than the impact of Canadian income taxes.
RE: Question 3, currency neutral (currency hedged) index funds tend to be less tax-efficient because the currency contracts can create taxable capital gains when they are renewed. (I don’t recommend hedging anyway, even if it were tax-efficient.)
Just out of curiosity… are you an Archer fan?
Cyril… Lana…
@Toni: Glad someone else gets my inside jokes. :)
Hi there,
I have decided to invest in the following Indexes:
1. Vanguard S&P 500 ETF (VFV)
2. Vanguard FTSE Canada ETF (VCE)
3. Vanguard FTSE Emerging Markets ETF (VEE)
4. Vanguard Canadian Aggregate Bond ETF (VAB)
How do I decide how much to allocate to each of these funds?
Thanks!
I disagree. Over time, all gains and dividends in a RRSP are 100% taxed, no dividend credits, no foreign tax credits, no gains deduction…just the raw top tax rate. And add up CPP/OAS/CPP for a coup, your marginal rate is at least 25% but probably much higher.
In order:
1) Best investment is your home. Reducing your mortgage has a zero risk 4.5% or better return on a 3% mortgage. Why is simple, tax paid money goes to mortgages. 3% mortgage needs a 4.5%++ return in an RRSP. Second, the home you live in comes without inflation and gains taxes. Can’t beat that. Buy it at $265k in 2004, sell it 50 years in for retirement home for say 1.5 million – NO TAXES ON THE INFLATION. Also, if you lose your job at 55, no-mortgage is no usual no financial worry. Do some stocks to learn the ropes, but main trust if mortgage reduction first.
2) TFSA, exclusively Canadian investments and pack it up good even if your spouse isn’t working. Its like a mini illegal no tax offshore account. A smaller version of your home but great for investing in Canada. You get no credit for foreign taxes so no reason for foreign investing here. No Canadian tax considerations, you only invest for the simple reason, gains+dividends = total return. Yep, total return, nothing else. This is to minimize your lifetime tax load and if you need a roof and short on cash at 66, well, no tax bumps to tap the TFSA,
3) Cash investment accounts, in today’s dollars at least $200k for everyone, as need a car? You will pay less taxes and less interest if you pay cash and pay gains taxes at 50% than RRSP at 100%. Its also good in other respects like layoffs and the like. Unless you anticipate no gaps in taxable income inside of 10 years, you really should not use a RRSP.
4) RRSPs should NEVER be done unless you have a solid tax plan like income averaging or just enough in that you can LIF it for a small pension. Its pretty easy to defer 34% taxes on contributions to be retired later on, CPP/OAS/GIS other pension and investment income to push you into a 43%+ tax rate on withdrawals. I call this the tax trap, and yes, I made this mistake. If you need a roof, short on cash — its 100% taxed at your marginal rates. You also do not get credits for capital gains and dividends. Say in your 50s, early 60s, drop $100k in. Oh, and if you die with a $500k RRSP, expect $230k of it to go to Ottawa. Only way RRSPs can beat TFSAs is if tax rates go down big, and I think you will see pigs fly first.
5) Note, RRSP/LIRA/LIF carry the largest liability on death. If your wife can roll them over, to not have to get a wallop tax hit, but you do not want it so big it pops you to a 40%+ tax rate if you live to be 100+. Govmints love this mistake. Tax liabilities of RRSPs can be punishing.