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.
Withdrawal symptoms
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.”
When you say “immediately” do you mean we can contribute $4500 to our TFSA today? Or the day the budget is voted on? (I assume voting day)
Thanks for the summary!
@Scott: The budget specifically says the increased contribution room applies in 2015, but I don’t see any benefit in rushing out to make the additional contribution today. Seems prudent to wait until all the details are clear.
One more thing to note, there is still a risk that the budget does not pass and the additional $4500 would then be considered an overcontribution. So I would just hang on to the funds in a non-reg for now.
The TFSA increase sure sounds great but it hasn’t been rolled out very well planned. They say it’s effective Jan 1st 2015 but yet didn’t tell us till yesterday (april 21st).!! So to me if any of us believed the talk of the increase last year we would have put the $10,000 in Jan 1st and actually wouldn’t have overcontributed per the budget of yesterday.
I called BMO investorline. The representative said they are suggesting to clients to hold off going over the $5500 limit for now. They got basically the same info as we did and havn’t been in touch with CRA yet.
Not knowing exactly when we can put the extra in is costing us all money since we have money in non reg that we pay taxes on and that could be in the tfsa now not paying tax on.
Another footnote, the TFSA will no longer be indexed to inflation. A small price to pay for the huge increase.
“Clients over age 18 who have not contributed since the TFSA’s creation in 2009 now have $41,000 in contribution room. Carol Bezaire, vice-president of tax and estate planning at Mackenzie Investments, says CRA won’t penalize anyone who adds another $4,500 to their TFSA after April 21, 2015, even though the budget hasn’t technically passed yet. That’s because CRA considers the budget’s pronouncement law.”
I’ll be waiting until I see the new limit posted on the CRA’s website, or see it reflected in my CRA My Account TFSA room calculation before I plunk in the extra $4500. Neither of those is the case at the moment.
“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.”
I have a maxed out RRSP and a maxed out TFSA; 68K and 48K respectively.
My RRSP contribution room is adjusted every year due to my pension plan contribution.
In my case, the amount in my TFSA represents a significant portion of my net worth and I have managed the portfolio accordingly indeed.
The TFSA will soon catch up with the new contribution rules. This will be interesting.
Thanks for the blog Dan.
Best,
HD
I should add that my margin account balance is 84K.
Will the May 2 webinar ‘Building the Perfect ETF Portfolio’ be available at another time for those of us who are unable to make it at that time?
James is correct. CRA says it will not penalize anyone who invests another $4500 into there TFSA. CRA considers it law as stated on its web-site, so might as well get in for extra distributions, it will take months before CRA gets around to adjusting the amounts on its web site, they can’t even tell you your new contribution room every jan 1st. It takes a month or longer for them to post my available room.
@Darby: Yes, the webinar will be archived on the Canadian MoneySaver site. Thanks for your interest.
@markymark
Can you or someone provide a link where a CRA representative says this?
There’s some very confusing verbiage about “Synthetic Equity Arrangements”; does this affect any of the swap-based ETFs structures?
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
Another part of the budget that is of interest to index investors: it seems that the government is finally doing away with swap-based ETFs (eg HBB, HXT).
See this article: http://business.financialpost.com/news/economy/some-of-ottawas-budget-tax-windfall-could-come-from-canadas-big-banks?__lsa=4466-7a21
CCP You missed something important i think:
“Under a proposal in the federal budget, banks will no longer be able to claim an income-tax deduction on dividends paid by Canadian companies under certain derivatives contracts.”
http://www.bloomberg.com/news/articles/2015-04-21/canada-closes-c-1-24-billion-tax-loophole-for-banks
Also, page 1
http://www.dwpv.com/~/media/Files/PDF_EN/2015/2015-04-21-2015-Federal-Budget-Tax-Highlights-EN.ashx
From my understanding, since it seem specific to dividends of Canadians companies, this would only affect HXT and probably mean only higher MER and not the end of the ETF.
Daniel, missed your post before i posted mind.
If you read carefully, it only concern “dividends paid by Canadian companies”. AFAIK, there is no tax credit for foreign dividend and interest so HXS and HBB are safe :)
I am checking into the swap issue and will report back. Too early to jump to conclusions.
I have over $100k of US listed ETFs in a TD Waterhouse taxable account? I thought I only have to report assets held outside of Canada. These are held in a Canadian brokerage account – doesn’t that mean they are held in Canada as tax reporting is done by TDW?
Zaphod, you need to fill the T1135 form or face possible penalties
The T1135 penalty is $25 a day up to a maximum of $2,500 per year you had to file the form. Canadians have had to report this property since 1998. If you missed a year, submit the form(s) through the CRA’s Voluntary Disclosure Program to correct previous tax returns.
Your yourself an accountant ASAP :)
I’m in the same boat as Zaphod with more than $100k in foreign investments in a Canadian brokerage taxable account. After seeing how huge the fines are I’m wondering a few things:
1) is there a difference between holding the Canadian equivalent & the original US listed ETF like Vanguards VUN vs VTI? I’m getting the impression that VUN wouldn’t count for the T1135 but VTI would.
2) It appears that just owning over $100k in foreign investments requires filing the T1135, even if you haven’t sold any of it yet. ie. buy and hold investors would still need to file T1135?
3) It seems that not filing the T1135 could be very expensive with fines even though all taxes were paid in full correctly and on time. It blows my mind that CRA could fine someone even though they made every honest effort to pay their taxes correctly. Maybe I’m missing something.
@Canadian Couch Potato – please consider a write up on the dangers of not filing T1135, what counts towards it, etc. AFAICT, this article is the first to mention this form.
While I do appreciate the sentiment, and I agree that we “likely” can contribute the extra to the TFSA today, prudence and patience are a better option until it is more clear. I can just imagine CRA’s reaction to “But markymark on the internet told me I could!”
@Dean: 1) Yes, as you suggest, a Canadian-listed ETF like VUN is not considered foreign property, while US-listed ETFs such as VTI must be reported. This is one more reason why holding US-listed ETFs in taxable accounts is becoming less and less appealing.
2) You’re correct. It doesn’t matter whether you sell anything: you need to report foreign holdings over $100K even if you are a buy and hold investor.
Some links that may be helpful:
http://www.advisor.ca/tax/tax-news/understanding-the-new-t1135-151683
https://www.pwlcapital.com/en/Advisor/Toronto/Toronto-Team/Blog/Justin-Bender/April-2015/How-do-I-report-my-US-listed-Vanguard-ETFs-on-Form
@CCP Thank you for the reply and also for this article. It’s fortunate that I subscribed to the RSS feed otherwise I would have never heard of this nasty T1135 form. Sadly my accountant has never mentioned this form so now I have to go back and do a ton of paperwork. I’ve owned US-listed Vanguard funds since 2006 and have mostly bought and held them. Going back to calculate the maximum fair market value in each year is going to be a nightmare. Being a couch potato I didn’t realize there would be this much work involved with US-listed ETFs. The appeal of the lower MERs is probably offset by the paperwork required.
I don’t imagine Vanguard offers a VUN for VTI swap program? ;-)
Re: filing T1135
Does VYN and VXC held in my Questrade US dollar account have to be stated?
Tks, for your advice
@Bob: Do you mean VYM, the Vanguard High Dividend Yield ETF? If so, then yes, because this is a US-listed ETF. VXC is a Canadian-listed ETF and does not need to be reported, but should not be held on the USD side of your account as it trades in Canadian dollars.
Regarding how the budget announcement will affect swap-based ETFs, I asked Horizons for a comment and they provided the following statement from Steve Hawkins, co-CEO and CIO, Horizons ETFs Management (Canada) Inc:
Go ahead and make your new TFSA contributions today:
http://business.financialpost.com/personal-finance/tfsa/after-some-confusion-banks-now-letting-canadians-top-up-tfsa-for-2015?__lsa=5b62-d5db
While there may be a legitimate reason to argue the TFSA increase will reduce needed government revenue, it blows my mind that the opposition is marketing it as benefiting the rich and not helping the middle class.
When you’re a millionaire, an additional $4500 that is tax free investment wise is pocket change, less than 1% of their assets, whereas for a middle class earner, even putting in part of that will be a major part of their assets, and they gain a lot more benefit percentage wise. It’s the poor that does not benefit from it. The increase is actually primarily a middle class tax relief.
I normally prefer the Liberals over the Conservatives, but this stinks of political play, just opposing policies because it’s proposed by the other party, regardless of merit.
Anyways, this is a very interesting article, I didn’t think of asset allocation in terms of growth potential, which gives more advantage to putting bonds in RRSPs and stocks outside of them. I’m also very interested in hearing more about the swap issue.
Mike April 23, 2015 at 7:58 am #
Mike you can always man up and make the phone call to CRA yourself if you don’t believe what you read.
@markymark
I called CRA short time ago, the agent told me it’s just a “proposal” and not yet approved.
If CRA told the banks it’s okay, why did CRA tell me it’s not and the limit is still $5500 ?
With regard to filing form T1135 to report USD investments it is my understanding that it is the initial cost of the investments that we use to determine whether or not the form must be filed not the current value.
On the CRA website under ‘Who has to report?’ it says:
“Canadian resident individuals, corporations, and certain trusts that, at any time during the year, own specified foreign property costing more than $100,000”
We jointly own a U.S. condo as well as individual investments in VTI and VXUS but until their total cost goes over $100,000 it is my understanding from my accountant that we are not required to report. The total cost would only go over the threshold if we were to buy more.
Correct me if I am wrong please.
Also, with regard to filing a T1135, if these investments were held in an RRSP are they treated differently than in a non-registered account?
Re T1135:
It isn’t really a nightmare to report US securities held in Canadian brokerage accounts. Just get your account statements out.
According to CRA web documents:
The total value to be reported is the highest fair market value at the end of any month during the year in addition to the fair market value at year end.
The exchange rates used should be as follows:
Maximum fair market value during the year – the average exchange rate
for the year.
Fair market value at year end – the exchange rate at the end of the yea
You will also need to calculate your gain/loss and income on the foreign holdings, which you should have anyways when filing your taxes, from your capital gains summary and tax slips (T3, T5).
See:
http://www.cra-arc.gc.ca/tx/nnrsdnts/cmmn/frgn/1135_rprtng-eng.html
… and the instructions on the form itself:
http://www.cra-arc.gc.ca/E/pbg/tf/t1135/t1135-14e.pdf
@Darby: Yes, the $100K threshold refers to the book value of the foreign property. But the T1135 form also asks you to include the maximum market value during the year and the year-end market value. And it asks for the amount of income received.
The T1135 is not required for investments held in an RRSP or TFSA.
@Darby: Note that if your condo is for personal use and generates no income, it is not necessary to report it on T1135, it is not included in the $100,000 threshold.
I have an apartment in Asia. I bought it 8 years ago. Still paying the mortgage. At the time of purchase, the value was way below 100K. I haven’t followed the market value. It may have reached 100K. I have been in Canada for 3 years now and haven’t reported this property. Do I need to report this at the time of filing returns in Canada? I have already filed for this year in Feb itself and received the refund also. Do I need to do anything now or should I think about it next year? I earn rent from that property and the income is around 10K per year in CAD.
@Satuk: There are penalties for not checking the foregn holdings box on your return, even if you’ve paid all the taxes on your income property. There is a voluntary disclosure process that you can use to report this late that should allow you avoid having to pay any penalties. See:
http://www.cra-arc.gc.ca/voluntarydisclosures/
@satuk: Oh, and it is not too late to file the T1135 for this year, you have another week.
@Satuk: But if the property is the only foreign holding, you are not required to report it if your cost was less than 100K Canadian. If you have securities too, you might be over that.
While doubling the TFSA contribution limit is nice, I still consider this a budget for the rich. When you have your mortgage, RRSP, RESP and student debt to deal with, how are you supposed to save $10K a year? Clearly, baby boomers and wealthy people will benefit.
Re: form T1135
Nowhere do I see maximum market value during the yr and yr end market value required on this document. It says maximum cost amt during the yr and cost amt at yr end. Makes no sense so I pan to leave it blank because who would know?
Correction: I meant to say I will fill in the purchase price pd for it yrs ago in both boxes
@Bob For US-listed ETFs held in Canadian discount brokerage accounts, it looks like #7 on the T1135 is the part to fill out. It has the max market value. This is assuming you’re using the 2014 form and not the 2013 form.
CCP’s reply to my post above had a very useful link:
https://www.pwlcapital.com/en/Advisor/Toronto/Toronto-Team/Blog/Justin-Bender/April-2015/How-do-I-report-my-US-listed-Vanguard-ETFs-on-Form
@Sean Cooper: If you’re one of the millenials who has chosen not to have a mortgage, squirreling away an extra $4500 a year is not difficult.
@Doug
Thank you for the response. The cost of my property, rental income and securities I hold in another country all together do not definitely exceed 100K. They will be way below that.
Would the CRA also consider the current market value of the property? It might fluctuate based on the currency exchange. I won’t even know how to assess the current value of my condo unless I put it for sale and see how the offers are. I am not planning to sell it anyway.
@Doug
As a follow up to my earlier query, in this case, do I still need to declare this to CRA? Can I do this online? Thank you.
http://news.gc.ca/web/article-en.do?mthd=index&crtr.page=1&nid=966849&_ga=1.33131518.1301805673.1427984701
@jake & markymark, etc. It now says on the front page of the CRA website that you can invest up to $10,000 thsi year in your TFSA.
I find it interesting to note that if the inflation rate for the next 20 years is 3%, that the annual TFSA contribution limit will be back to less than $5500 in today’s dollars…not such a great deal after all?
Regarding the change in the RRIF rates, I wonder if by allowing seniors to defer withdrawals, that the CRA might end up collecting even more in taxes. We have to remember that we can’t defer beyond the last surviving spouse’s terminal tax return…and that all remaining RRIF’s must be declared as income, often at high marginal rates, and payable by the estate.