Yesterday’s federal budget included several changes that will affect investors—in the future if not immediately. Let’s look at the three most important announcements, with a focus on how they may apply to those who use an index strategy with ETFs:
- The biggest headline was the increase in annual TFSA contribution room from $5,500 to $10,000, beginning immediately.
- Minimum withdrawals from RRIFs were reduced significantly.
- Investors who hold foreign property (including US-listed ETFs in non-registered accounts) will be able to report this to the Canada Revenue Agency in a more efficient way.
Asset location just got more interesting
If you’re juggling TFSAs, RRSPs and non-registered accounts, asset location is a challenge. To manage your portfolio in the most tax-efficient way, you should consider which asset classes (equities, bonds, REITs and so on) are best held in which type of account. This isn’t straightforward. You can make a strong argument for holding bond ETFs in a registered account because they are so tax-inefficient. But if a TFSA can shelter you from taxes over an entire lifetime, shouldn’t it be reserved for assets with the highest growth potential—in other words, stocks?
There is no single right answer: an awful lot depends on individual circumstances such as your current tax rate, your expected tax rate in retirement, whether you need liquidity, the size of your portfolio, your overall asset mix, and the specific funds you use. And let’s not forget that the most important driver—the future returns of stocks and bonds—can never be knowable in advance.
That said, the changes announced in Budget 2015 will have an important influence on asset location decisions in the future. In a white paper published last year, Asset Location for Taxable Investors, Justin Bender and I didn’t even include TFSAs in our analysis, because at the time you could only contribute a modest $31,000. “If you have a maxed-out RRSP and significant non-registered savings,” we wrote, “this amount would not represent a significant portion of your net worth. That will change in the future, but for now TFSAs are not a major factor in the asset location decision.”
With TFSA contribution room now almost double what it was, the thinking about asset location will need to evolve. Right now, if you’ve maxed out your RRSP and your TFSA, chances are the former is much bigger—indeed, for well-off investors the RRSP might be 10 or 20 times larger. But for younger folks earning modest incomes, TFSA room will now accumulate more quickly than RRSP contribution room. And by the time they’re in their peak earning years, the TFSA may supplant its older cousin as the primary retirement savings vehicle.
The new lower minimum RRIF withdrawal rates will also affect asset location decisions. In our paper, Justin and I argued that investors need to consider the future tax implications of forced RRIF withdrawals in retirement. That was an argument for holding bonds in an RRSP and equities in a taxable account (assuming RRSPs were maxed). “Holding higher-growth equities in an RRSP would defer more taxes today, but the investor would also end up retiring with a larger registered account (relative to if they had held lower-yield fixed income). That could result in significantly higher tax bills during retirement, as well as a clawback of Old Age Security benefits.”
Under the new rules, the required withdrawal rate will be 5.28% at age 72, down significantly from the current 7.38%. For an investor whose RRIF is valued at $500,000, that reduction amounts to about $10,000 a year. So the new RRIF schedule will allow seniors to draw down their registered accounts more gradually, keeping their taxable income lower in retirement. That makes the argument for holding low-growth investments in RRSPs less compelling than before.
A break for those with US-listed ETFs
Finally, in one of the less publicized budget announcements, the feds made life a little easier for investors who hold US-listed ETFs in their taxable accounts. If you filed a tax return this month your accountant or advisor may have explained that the CRA requires you to report specified foreign property over $100,000 by filing a T1135 report.
Unfortunately, recent changes to the T1135 are onerous and confusing. The government admitted this in the budget text: “Stakeholders have commented that this approach has resulted in a compliance burden for some taxpayers that may be disproportionate to the amount of their foreign investments.”
According to the budget announcement, things should be easier next year, at least for those whose holdings in US-listed ETFs are between $100,000 and $250,000: “Under the revised form being developed by the Canada Revenue Agency, if the total cost of a taxpayer’s specified foreign property is less than $250,000 throughout the year, the taxpayer will be able to report these assets to the Canada Revenue Agency under a new simplified foreign asset reporting system.”
@Satuk: I’m not an accountant and can’t give you advice on this, but it seems to me that you wouldn’t need to file the T1135 based on what you’ve said in your message. I don’t think that you can file it electronically. I did my taxes using TurboTax, checked the box and filled in the details of the foreign securities, and did an efile. The software said that I needed to mail the T1135 in, and my notice of assessment said so too.
I did a happy dance for a couple of hours for the TFSA increase. It is just an incredible move by conservative party to get reelected. Well done! :)
In my taxable account I bought about US$61.1k worth of VBR in March 2014, and on November 10, 2014 bought a further US$35.7k worth. The total cost in US$ is easy to figure out, but the cost in Canadian $ is problematic — do I use the exchange rate at noon on the two days of purchase?
What exactly is the threshold trigger for reporting? A value of over 100k in Canadian Dollars derived from the sum of the costs of purchase of the 2 components? (In March 2014, the Canadian dollar was so much closer to par that the Canadian dollar purchase cost at that time was much less than it would be if we used an exchange rate for later in the year). Or the highest of any of the values including the total value in Canadian dollars at any time during the year?
And if I have to report, are the two values 1) Total value in Canadian dollars on November 30, 2014, and 2) Total Value in Canadian Dollars on December 31, 2014?
Report the maximum month end value using the average 2014 exchange rate of 1.1044664 in the “Maximum fair market value during the year” column, and the year end value using the year end exchange rate of 1.1601 in the “Fair market value at year end” column of the T1135.
@oldie: … I suppose that if the “Fair market value at year end” value is higher than the maximum monthly values (due to the exchange rate difference), you would use that for both columns.
@oldie” Man, I should organize my thoughts to respond in one message…. It is the current value, not the cost value that is to be reported. Simply look at your monthly statements and calculate the Canadian dollar values using the rates in the earlier message. Those rates are from the Bank of Canada web site.
@Doug: OK thanks! What a pain. Hindsight is great, but if I had only waited a month and a half to top up it would have been 2015, and the easing of reporting guidelines would have saved me the hassle!
A very, very important part of that budget has been overlooked. At the very end of the document, in Appendix 5 starting on page 461, there is a section named “Synthetic Equity Arrangements”; the measures contemplated in that section could have a huge impact on some of the more popular ETFs currently offered by Horizons.
@Michel: Please see the response from Horizons in the comment thread above.
Thanks RogerK I was 100 percent sure of what I wrote before any listing/web update by CRA.
Everyone should be happy now that its plastered on CRA web site, now go dump 41k into that TFSA and top it up with growth equities for the next few decades!!
I too would congratulate you on your good call if only you indeed had written what you said…but you actually copied word for word from Garth Turner’s Greater Fool blog post of April 22 which said…
“Can I put $10,000 in my account today? Is it legal?
Yes, go for it. Tax measures contained in federal budgets routinely take effect the moment they are announced. If that were not the case, people would have time to restructure their affairs to thwart the government’s intentions. So while the budget has not passed Parliament nor received Royal Assent, it’s a done deal as far as the CRA is concerned”
Thanks for the response. I am happy to know that I don’t need to file the T1135.
I was 100 percent sure of what garth wrote. There you go shame on me.
The $10,000 limit is “immediate” but if you look on the CRA website it says the limit has been increased under “proposed legislation.”
So what’s the deal? I’ve already maxed out my TFSA, but does this mean I can now contribute another $4500, or do I need to wait for the legislation to go through?
If I log into my CRA account, it still shows the limit as $5500, which is why I’m hesitant to contribute more.
The more I learn about the tax rules regarding US listed ETFs, the more I want to get rid of them. I managed to complete the T1135’s for 2014 for my wife and myself and it was a pain in the butt. Now I’m discovering if persons estate has more than $60k USD in US assets (including US domiciled ETFs), the executor of the estate would have to file a US estate tax return (Forms 706-NA and 8833) even though they may not end up paying any estate tax. Although in 2014 Canadians with estates less than $5.34 million probably wouldn’t have to pay estates taxes, they would still have some US paperwork to fill out. That’s not something I’d want to put my wife through.
For lazy couch potato investors like me, avoiding all US listed stocks/ETFs/etc. might be the best bet, even in TFSAs and RSPs.
@Dean: We’re coming to the same conclusion as well. There’s still a good case to be made for US-listed ETFs in RRSPs, but in non-registered accounts and TFSAs the case is getting weaker and weaker.
@CCP If a person passes away with more than $60k USD in US-listed ETFs in RRSPs, does the executor still need to file a US Estate tax return? If yes, I’d still avoid them.
I sure wish I had that sweet three ETF (VAB, VCN, VXC) portfolio right about now… ;-)
@Dean: Technically, yes, even funds held in an RRSP are considered US situs assets. Depending on the situation, however, it may well be worth continuing to use US-listed ETFs in RRSPs and paying an accountant to file the necessary paperwork upon death. It’s a not a particularly onerous obligation, and I am not even sure how enforceable it would be.
Just spoke with cra and they said that its OK to add the extra $4500 even though the legislation hasn’t been passed. ‘They will honor the new room’.
Very exciting! As my tfsa is more valuable to me than a rrsp.
Onwards and upwards to savings:-)
Will the bid/ask spread come down once more assets are in VXC and XAW ? Unless one has a big holding of index mutual funds in one account it doesn’t seem worth switching? The bid/ask spread on XAW today showed 0.49% which is more than the MER of the td e series US and International funds when combined plus a $9.95 commision to buy.
@Jake: I don’t see any compelling reason to switch from VXC to XAW or vice-versa: they are almost interchangeable. In any case, the bid-ask spreads remain a potential problems for a lot of ETFs. They seem to vary from day to day: my guess is you will not always see such a large spread, and as you say, this situation should be expected to improve as the ETF grows its assets. As always, use limit orders when placing any trades.
Don’t forget that the Liberals and NDP have already promised to roll the TFSA limit back down to $5500 if they get into power.
Maybe Canadian Couch Potato can interview some political party members about their ideas for how Canadians should be preparing for retirement?
As per comments above,
We’re coming to the same conclusion as well. There’s still a good case to be made for US-listed ETFs in RRSPs, but in non-registered accounts and TFSAs the case is getting weaker and weaker.
Getting out may not be so easy if one is at a point of having 700k+ in US ETF in unsheltered, held for a long time. Just the capital gain would be enough to make you want to take your ball and go home. So the question now seems to be do you stay the course and rebalance with US, or do you start buying Canadian and manage one more ETF. Is there an angle I am not seeing? Thanks Dan. I really appreciate your work.
The TFSA room increase is great! Pity most Canadians cannot afford to max out their TFSAs; but hey we all “own” overpriced houses :)
Bond funds sure taking a beating lately. Glad to hold half of my fixed income in GIC’s, nice to see them go up each and every day and reduce the volutility of my portfolio.
Does holding half of fixed income in GIC’s actually reduce the volatility versus holding all fixed income as Bond index funds? My understanding was that, assuming the remainder of the portfolio was in diversified equity indexes, generally the bond portion would be inversely correlated with the equity portion, tending to smooth out the bumps. I thought that diluting the Bonds with GICs (despite the advantage of providing a predictable amount of cash if needed at a certain future date) did not decrease the overall volatility as much as leaving an unchanged larger Bond component would. Perhaps more knowledgeable investors could comment on this.
Oh, I just read yesterday’s Couch Potato post by Dan regarding Bonds vs Cash, which addresses all my concerns (essentially confirming my suspicions expressed above).
I added $4500 to my TFSA online but I had to take my wife down to TD to add to her account. I asked the rep if she was being run off her feet with people coming in to add to their accounts and she said ‘no’.
She said most people are not aware of the higher limit and that very few on the people that bank locally have TFSA’s or RRSP’s.
From what I’ve heard from you and elsewhere, there is no consensus on whether stocks or bonds should be held in a TFSA. My thought then is to play the middle ground and do both. Of course, though, this would be complex with re-balancing and so on. So my thought is to use a TD comfort portfolio for the TFSA and maybe my RRSP too, leaving me with just unregistered for Canadian Couch Potato portfolio.
So I would have a TD comfort portfolio for my TFSA and another for my RRSP (similar size), and then a Canadian Couch Potato for unregistered. Re-balancing then would be quite simple, plus a little less emphasis on my own DIY investing.
Any thoughts on this strategy?
@Sam: You’re right that there is no consensus, because asset location depends on many factors, including your personal tax situation, and whether you might need your TFSA for short- to medium-term needs. Asset location is also less important if the decision is between RRSP and TFSA, as opposes to registered vs. non-registered. In general, you should not worry about holding a balanced fund in both your TFSA and RRSP to keep things simple. Are both of these accounts maxed out? If not, can you tax-shelter some of the Couch Potato portfolio you are planning to build in a non-registered account?
I’m self employed so income and tax uncertainty is partly why I can’t decide what goes best in my TFSA. I like the idea of equity ballooning the contribution room, but then I’m frugal so happy letting equity build untouched in non registered while sheltering interest income in registered accounts. So, the middle ground…
I currently have balanced funds in my RRSP and TFSA. I have some contribution room in each and I’m deciding whether to add to the balanced funds or, as you say, shelter some of my Couch Potato portfolio in there. That’s where the dilemma of what to shelter comes in, and me deciding to shelter a bit of everything, hence maybe just keep things simple and add to the balanced funds so that I have three portfolios (balanced fund in each RRSP and TFSA, and Couch Potato in unreg, which a fair bit larger). But then I’m not being the devoted Couch Potato I aspire to be :-(
Thanks for your insights!
Hi! I can’t seem to find this info anywhere: With regards to filling out a form t1135, do the following count as specified foreign property?
1) Cash Balance in a US Cash Account at Canadian Brokerage
2) TDB8152 investment in the same account as 1)
I couldn’t seem to find anything referring to whether or not these count. Thanks!
@Nicholas: TDB8152 is a Canadian-domiciled savings fund and is not considered foreign property, just like a Canadian mutual fund that holds U.S. stocks. The CRA’s description of foreign property does not include U.S. cash held in a Canadian brokerage or bank. It refers to “funds…situated, deposited or held outside Canada.”
The information you provide on your site is extremely valuable, thank you for your help.
I have a question about the T1135 form and whether TDB902, XAW.TO, and ZDB.TO are considered specified foreign property as I have them in a non-registered account?
I also have VCN.TO which is canada so believe it isn’t included in T1135 as well as IVV which I read on a BMO page that it is included in T1135.
@TDI: For purposes of the T1135, “foreign property” means stocks or ETFs domiciled in the US. This would include IVV, but all of the other funds you mention are Canadian, even if they hold foreign stocks (as is the case with TDB902 and XAW). This is one of the reasons I recommend sticking to Canadian-listed ETFs in non-registered accounts.