In my last few posts, I introduced the newly launched Vanguard Retirement Income ETF Portfolio (VRIF), explained where its 4% distribution comes from, and considered whether that payout is sustainable. Now it’s time to explore how you might use VRIF in your own portfolio— and when you should avoid it.
Using VRIF in a RRIF
With “Retirement Income” right in its name, it’s natural to consider using Vanguard’s new ETF in a RRIF account. RRIFs, of course, require you to make regular withdrawals, and many retirees receive these monthly. Since many RRIF holders don’t like to sell their holdings to free up cash for those regular withdrawals, VRIF’s monthly distribution schedule might be just the ticket.
But if you already have a RRIF, you’ve probably spotted the wrinkle. VRIF’s annual distribution is fixed at 4%, and unless you’re younger than 65, the minimum withdrawal rate from a RRIF is higher than that. For example, say you’re 72 at the start of the year and your RRIF holds 12,000 units of VRIF with a value of $300,000. At your age, the minimum withdrawal for the year is 5.40% of that balance, which is $16,200, or $1,350 per month. However, the distribution from VRIF will be only $12,000 annually, or $1,000 a month, so you’ll need to find a way to make up that shortfall.
Of course, in theory you could simply sell a few units of VRIF to free up that extra $350 a month, but this is inefficient, inconvenient, and doesn’t help retirees overcome their reluctance to sell holdings to generate income. Really, it defeats the purpose of using a monthly income fund. If you were resigned to selling units frequently, why not just stick with whatever ETF portfolio you were using in your RRSP before you converted it to a RRIF?
I’d argue there’s a simpler way to manage monthly RRIF withdrawals. At the beginning of the year, as soon as you know how much your required withdrawal will be, you can sell some holdings to raise that entire amount. (If you’re using a traditional asset allocation ETF for the whole portfolio, this is just a single trade.) Then you can put the proceeds in an investment savings account and set up a systematic withdrawal plan to make the monthly payouts. This requires you to do a little maintenance only once a year, which is about as easy as it gets. The truth is, there’s no such thing as a set-it-and-forget-it RRIF.
Using VRIF in a taxable account
VRIF is probably best-suited to income-oriented investors who hold it in a taxable account. Unlike with a RRIF, you won’t have to worry about minimum withdrawals, so you can simply arrange with your brokerage to have those monthly distributions sent to your chequing account and let the investments run on autopilot. No one can argue with that convenience.
So the question then becomes, is VRIF tax-efficient in non-registered accounts? And the answer is—sort of.
To break this down, let’s return to the idea that the cash flow from a monthly income fund has four sources: interest, dividends, capital gains, and return of capital.
Bond interest, of course, is fully taxable. Half of VRIF is made up of bonds, so it will generate a significant amount of interest, which is to be expected (and welcomed) in a monthly income fund. The problem is that today’s extremely low interest rates mean that most bonds are trading at a significant premium. This is an issue I’ve written about before: the full explanation is complicated, but the key idea is that premium bonds are particularly tax-inefficient.
The easiest way to identify an ETF full of premium bonds is to visit its web page and compare the fund’s “average coupon” to its “yield to maturity.” If the coupon is higher, the fund holds mostly premium bonds, and the larger the gap, the more tax-inefficient the fund will be. VRIF’s single largest holding is the Vanguard Canadian Corporate Bond Index ETF (VCB), which has an average coupon of 3.3% and a yield to maturity of 1.7%. That’s not a good combination in a taxable account.
As for dividends, these are only tax-advantaged if they come from Canadian companies: dividends from US and international stocks are fully taxable, like interest. Right now, only 9% of VRIF is Canadian equities, while 41% is foreign equities. So don’t expect to benefit much from the dividend tax credit.
Where VRIF does offer potential for tax-efficient income is through its distribution of capital gains. Remember that Vanguard expects about 60% of the annual yield to come in the form of dividends and interest, with the other 40% being generated from selling holdings and distributing the proceeds as capital gains. Only 50% of a capital gain needs to be reported as income, which makes this type of distribution much more tax-friendly than dividends or interest.
There’s a behavioral benefit here, too. As we’ve said, investors tend to love yield in all its forms, while at the same time showing great reluctance to sell their holdings to generate cash flow, even though the latter strategy can be more tax-efficient. Since VRIF will be harvesting gains behind the scenes, unitholders can enjoy the tax benefits without having to sell any units themselves.
The final type of cash flow from VRIF will be return of capital (ROC), through this expected to be rare. ROC, you’ll remember, is simply the fund paying you back some of your original investment. It’s useful for keeping the distributions consistent during periods when interest, dividends, and capital gains are not sufficient to meet those monthly targets. Since ROC is just your money being returned to you, it’s not taxable as income.
Fund companies like to frame return of capital as “tax-efficient cash flow,” as if it were a great benefit. In fact, it’s not much different from celebrating the fact that your ATM withdrawals are tax-free. And indeed, ROC is not without future tax consequences: it reduces your adjusted cost base on the holding, which means that when you eventually sell your units of the ETF, you’ll realize a larger capital gain (or a smaller capital loss).
Overall, then, VRIF is likely to be about as tax-efficient as your average globally balanced fund, and somewhat more tax-friendly than a monthly income fund that focuses on high-dividend stocks rather than capital gains.
Who shouldn’t use VRIF?
Now that we’ve considered the practical implications of using VRIF to make monthly withdrawals from a RRIF and a non-registered account, let’s consider some situations where monthly income ETFs like this are not appropriate.
We’ll get the first one out of the way quickly, because I hope by now this has become obvious: monthly income funds are absolutely not a substitute for savings accounts. VRIF’s 4% distribution is not the same as a 4% return: like any portfolio of stocks and bonds, this ETF can easily lose money over short periods, so it is not the place to stash your emergency savings, nor the down payment for the house you expect to buy next year. Yes, interest rates on savings accounts are very low, but that’s the price of safety.
By the same token, VRIF is not a replacement for bonds. While the 4% yield is about double what bonds are delivering, substituting VRIF is effectively selling half of your bonds and replacing them with stocks, making your portfolio much riskier.
Others have asked whether a fund such as VRIF would be appropriate for someone making regular contributions to their portfolio, as opposed to drawing it down. Since these investors don’t need monthly cash flow, they suggest setting up a DRIP and reinvesting all of the distributions.
If anything I’ve written over the past couple of weeks has sunk in, it should be clear that such a strategy makes little sense. Since there are already excellent one-ticket balanced ETFs available for accumulators, it’s hard to understand why anyone would use a monthly income fund for this purpose.
For starters, we know that a significant amount of VRIF’s distributions will come from capital gains, which means the fund manager will regularly sell securities to harvest these gains. While this makes sense for investors who need regular cash flow (and tax efficiency in a non-registered account), it’s not a sensible strategy for investors who are planning to reinvest the proceeds. If you held VBAL or VGRO instead, would you periodically sell shares to realize gains and then immediately repurchase them? In an RRSP or TFSA this is merely unnecessary, but in a non-registered account it will generate taxable gains for no reason, when these could be deferred indefinitely.
As we’ve said, return of capital is not likely to be a significant part of VRIF’s distributions, but it makes up a huge chunk of the yield from many other monthly income funds. A surprising number of investors use these funds during the accumulation phase of their lives, reinvesting the distributions rather than spending them. While there is no outright harm in this, it’s hard to make a case for using a fund that is specifically designed to generate cash flow if that cash flow isn’t needed. That’s especially true if those distributions include realized capital gains (which could be deferred) and ROC (which just creates the illusion of income).
If you’re in the accumulation phase of your investing life, stick to traditional ETFs that distribute only interest, dividends and capital gains that can’t be deferred. Vanguard’s own VBAL and VGRO are excellent examples, and there are equally good choices for any target asset mix.
There is no benefit to using a fund that generates regular cash flow if you are just going to reinvest the payouts. However, if you rely on regular withdrawals from your portfolio to fund your spending, then VRIF—with its thoughtful design, low cost and broad diversification—can be a simple, sustainable solution.
Many thanks for your analysis of VRIF. It will be a significant contributor to my decision making.
I’m curious how the income from VRIF is reported for tax purposes (assuming a non-registered account). Does Vanguard break down the different sources in their slips they provide? Canadian dividend, interest, capital gains, etc.?
I think the convenience of VRIF would evaporate if it became a pain to figure out at tax time.
Thank you for this series, and also for providing this kind of generous, thoughtful guidance for years now. I’m grateful to have been exposed to it.
My thinking is that selling ETF shares to fund living expenses in retirement would create regular occasions for doubt and anxiety, especially during long down markets. Better to have the trades happen automatically, out of sight. Seems comparable to the benefit of the automatic rebalancing in asset allocation etf’s, where you’re spared the experience of personally having to make stomach-churning trades.
Regarding premium bonds, the specifics are too daunting for me to even begin to try to figure out. One aspect I wonder about is the effect of the low tax bracket a person who stops working is likely to enter and how much that shrinks the problem. I also wonder whether ZDB’s advantage is getting any smaller in these extreme times as their orginal mandate necessarily needs to be watered-down. Their target is now listed as “coupon rate equal or less than 1.4 times the yield to maturity” on the ZDB web page.
Thank you so much for this series of articles. I’m curious to know the advantages or disadvantages to owning VRIF in a TFSA and reinvesting the proceeds. I realize this is somewhat against the grain as it isn’t being used for income. But for a senior might it be a way to enjoy a reasonably reliable approximate 4% return although, of course, not entirely risk free.
@Bill G: Yes, your T3 slip will provide a breakdown of all of the income types, so tax reporting for VRIF should be straightforward.
@Moti: Thanks for the comment. It’s true that if you’re in a low tax bracket in retirement, tax optimization may not be significant issue. For those who are concerned about tax-efficiency, ZDB still offers some benefits, even if these are not as dramatic as they used to be.
The premium/discount bond issue can indeed be complicated, but it’s easy enough to compare the coupon to the yield to maturity (YTM) on any bond fund. Remember, you want this gap to be as small as possible in a taxable account. (It doesn’t matter in an RRSP or TFSA.) For ZDB, the coupon is currently 1.94% with a YTM of 1.25%, which is about as wide as I have seen it. However, ZAG has the same YTM and a coupon of 3.10%, so there is definitely still a tax advantage with ZDB. Another alternative, if you don’t need liquidity, is GICs. With a GIC, the coupon and YTM are always the same.
Thank you for a very good series on VRIF.
Great analysis. Would be great if the website provided these articles in a printer-friendly format.
Can you hold the VRIF is a TFSA, and have the income go into another account for you to spend?
Any use for it in an RESP?
@fionag11: Making regular monthly withdrawals from a TFSA seems like a hassle. I’m not even sure most brokerages would do it, and you’d need to keep track of the withdrawals if you ever plan to make contributions again in the future.
@Matt and George: Regarding using it in an RESP or TFSA and reinvesting the distributions, this is the issue I discuss in the last section of the blog. It doesn’t make any sense when there are better options for one-fund portfolios. VRIF is best-suited to investors who need the monthly cash flow for spending.
So to recap, VRIF not optimal in an RRIF because it won’t hit minimum withdrawal rates by itself. (Maybe this paints the ROC-intensive funds you mentioned earlier in a somewhat better light?)
It’s not optimal in a TFSA because monthly withdrawals seem like a hassle,
It could be decent in a taxable account, but is not the best option for the accumulation phase. Meaning in order to have VRIF in my taxable account, I’d first have to sell a significant part of VBAL (or whatever) to buy it? Triggering lots of capital gain taxes by itself?
For all its bling, I don’t really see a great spot / clear recommendation in any of the account types. Maybe that’s a pass for me.
One great use case I could think of is for a person who obtains a lot of money at once, close to or already in retirement. Like an inheritance, or a lottery win. That could go into a taxable account and prop up whatever else the person was already investing for retirement.
@Jakob: I think it’s fair to say that the ideal use for a fund like VRIF is in a taxable account that you’re using to generate monthly cash flow to meet your spending needs.
What about using VRIF in an RRSP when retired but before being forced to convert to a RRIF at 71 years of age? That way you have the flexibility to withdraw any amount (or just the 4% distribution), and pay the tax when your income is kept below a given tax bracket.
Thanks Dan for all you do.
I really appreciate the analysis and commentary on the VRIF. I can confidently say that your work has saved us considerably..by not changing a thing we have in place…VBAL and VGRO. Well done.
Thank you Dan. I’m officially an investing nerd now thanks to you!
E series, vgro, investease…the Madness.
Be well in these crazy times
Scott
Where does more of risk lie with VRIF?
For example, if I were to place $250,000 in VRIF, over a 5 to 8 year period, what are the main risks? Is it possible that in 5 years, the account drop much lower than my initial investment of $250,000 ?
Thank you very much
Thanks Dan for another great series of posts!
This is more out of curiosity than anything, but any theory on why the global bonds are weighted so heavily towards non-US (and why nearly all the government bonds are outside NA)? I understand from a previous answer that there are reasonable arguments for holding non-Canadian bonds and the currency hedging strategy should alleviate the lower yield outside of NA, but VRIF seems to be actively preferring non-NA bonds, especially for government. Any idea why this is?
Dan, thanks very much for this fine and comprehensive look at VRIF.
@James Stein: VRIF is no more or less risky than any other balanced fund of about 50% bonds and 50% stocks. It can certainly suffer a loss of 15% to 20% in a brutal bear market, though it is unlikely to lose value over a period of five to eight years. Remember, however, if you are drawing down 4% of the fund every year then it would be more likely to see its value dip below your original amount.
@Graeme: The honest answer to this question is that I don’t know why Vanguard has determined the expected return for global bonds is higher than Canadian or US bonds. Their model for determining the asset mix is not public.
@Brad: I’m not sure there is any specific advantage to using VRIF in that context, compared with a different asset allocation ETF.
Maybe the choice of global bonds is not for higher expected return but for lower expected volatility, to support his structure where cashflow needs to be ongoing and fixed. Vanguard published a list of expected returns, together with expected volatility, for difference asset classes, and the volatility they forecast for global bonds is lower than for the aggregate US bond market (there are no forecasts for Canadian markets): https://americas.vanguard.com/institutional/articles/research-commentary/markets-economy/market-perspectives.htm
I wonder about foreign withholding taxes for VBG. I assume foreign withholding taxes apply to coupon payments the same as dividends? Also, is VBG a wrapper around BNDX? Thinking about the 5.9% Canadian bond allocation in VBG, coupon payments from it would have a cut taken by the Canadian government on the way to BNDX in the US (assuming Canada imposes withholding taxes like other countries, which I’ve never had to think about, being located here). Then, when that money finds its way into BNDX distributions, the US government would take out withholding tax before it gets to VBG in Canada. There would also be costs for currency hedges going both ways, which actually cancel each other out, with the money starting as CAD and ending as CAD.
@Moti: Just to address the foreign withholding tax issue, this does not typically apply to bond interest, only to dividends. Neither is there currency hedging “both ways,” as BND and BNDX do not hedge to the US dollar. There is only the one hedge, to CAD.
Thank you very much for the answer on withholding tax and bond interest. Of course that’s good news. Regarding two-way hedging, I meant that if BNDX hedges its exposure to the currencies of its underlying holdings, and Canadian bonds are a (small) component of those, there would be hedging of that CAD exposure to USD (for the benefit of the American holders of BNDX). Then, if VBG is just a wrapper around BNDX, but a wrapper which adds hedging between USD and CAD, that that hedging would include the value of the originally Canadian component. (It occurs to me that there would also be some cost of currency conversion, as well, not just hedging). It just seems like there are likely to be inefficiencies like this in VBG, a result of trying to adapt an American EFT for Canadian. By choosing the Canadian bond component of VBG, I was trying to choose the most extreme potential example of inefficiency. I’m sure there are very good reasons to use VBG that outweigh any inefficiencies, but I’m curious about the details. The question isn’t question specific to VRIF, it’s just brought to the forefront by VRIFs eye-catching weighting of VBG.
Can i make a request that you consider covering esg etfs? RBC introduced some in september, bmo in january and wealthsimple recently did as well and i’m confused what to choose. Thank you for your consideration.
@christina: Thanks for the suggestion: I will likely do something on ESG funds in the future.
For someone comfortable with an all-equity allocation for long-term higher dividend income yield, would a combination of VDY, VIDY, and VGG make more sense than VRIF? These would allow for some capital appreciation without the erosion caused by the use of capital gains to fund some of the returns. I realize a weighted yield would be below VRIF’s target of 4%, but perhaps not too much.
As well, Vanguard tends to use less ROC than iShares/BMO, particularly with monthly income portfolios, which would result in a smaller ACB for eventual estate planning. Does this make sense or are these concerns not as big a deal with VRIF?
@BartBrady: At the most basic level, you’re really just asking if it’s better for your portfolio to be 50% equities or 100% equities. If you’re able to tolerate that kind of volatility (and few people are), then clearly the dividend portfolio would have a higher expected return than VRIF.
As for the effect of ROC on ACB, remember that less ROC would mean a higher ACB, not a lower one. And therefore the eventual capital gain would be smaller, which is presumably a good thing for estate planning.
Many thanks Dan, I got ACB backwards! We’re balancing a need for income (not the sole source) for a family member while preserving capital for the estate. I was looking at other monthly income portfolios and was surprised to see how much of the distributions come from ROC, not something we really want.
Hello Dan,
Excellent explanation on VRIF found.
I was wondering if this fund would be beneficial to have as a retirement source of income for retired professional whose retirement investments are in professional corporation ? Thank you very much for your prospective.
Andrzej
@Andrzej: Holding VRIF in a corporation would be similar to holding it in a personal taxable account so, sure, if you are making monthly withdrawals from the corp in retirement this fund might be suitable.
Hi Dan,
I am thankful that I ran into your site and read this article about VRIF. My retired parent has cash and I am helping him to set up his retirement income account. I saw VRIF on Vanguard site and was curious about the fund’s suitability for my father (who does not like the market). I was bit worried putting the money in there as this is a new fund. Should that be a concern? Also, if we put in $700K, at $25 per unit = 28K units. At current $0.0833 monthly distribution rate, can we expect about (28K * 0.08333) $2333 per month? Also, would it be wise to put the entire cash in this fund or would you recommend some other funds along with VRIF for further diversification?
Thank you.
@JP: The fact that VRIF is a new fund poses no risk whatsoever. And if the asset allocation is appropriate, then there is no need to diversify with other funds: VRIF is extremely well diversified already. But the issue is that VRIF is 50% stocks and you have said your father “does not like the market.” If he is nervous about investing in stocks, then this is not the fund for him. He would need to choose a more conservative portfolio.
In terms of the distribution, you’re correct that a $700K investment in VRIF would be expected to pay a distribution of $2,333 per month.
Hi Dan,
I’d be interested in how an investor withdraws income from your model portfolios for living expenses once they’ve reached their investment target? I realize the answer will totally depend on an investor’s individual circumstances but do you have any starter tips/resources for those of us who are looking to make this transition aside from using VRIF?
Thanks!
@Linda: As you acknowledge, the specifics will vary a lot for different people, but in very general terms, a drawdown strategy might look like this:
– Keep about one year’s worth of cash flow in a savings account
– Keep another two to five years of cash flow in a GIC ladder
– Keep the rest of the portfolio in a single asset allocation ETF appropriate to your risk profile
– Once a year, when a GIC matures, use the proceeds to top up the savings account to provide the next year’s worth of cash flow
– Sell some units in the ETF and use the proceeds to buy a new GIC to maintain the ladder
@Dan, in your general drawdown strategy, what is the reasoning behind keeping 2-5 years of cash flow in a gic ladder? Is it to ensure you don’t have to withdraw funds during a down-market? Or would you still sell some units from the ETF in order to buy another gic even during a down market?
@Cory: You have the right idea. The GIC ladder provides a stable buffer, so if one happens to mature during a bear market you could choose not to renew it immediately. Part of the benefit is psychological, too. It’s comforting to be able to tell yourself, “No matter what happens in the markets, I have several years’ worth of cash flow guaranteed.”
I bought some vrif in my tfsa but want to change to another etf. When I sell the vrif I can buy another etf with funds? At any point?
If I get a dividend for the first month, do these funds go into my tfsa account and i can then buy other etf?
These scenarios are all within the tfsa are they not? I am with wealthsimple.
@Wendy: Yes, if you sell an ETF, you can purchase another one with the proceeds immediately. Any dividends from your ETF would simply be paid into your TFSA in cash, and you can use that cash to repurchase more shares.
Thanks for this multi-part analysis. I’ve read some pieces of yours previously, but I’m not completely familiar with the site. When you speak about drawing down cash, you describe reserving several years of “cash flow” in a savings account and a GIC ladder. How do you define “cash flow” in this context — anticipated expenses in excess of guaranteed payments such as pensions? Thanks again.
@Deborah S: Thanks for the comment. Yes, by cash flow I mean the amount you expect to withdraw from the portfolio in order to meet regular expenses. I tend to use this term instead of “income,” as I like to make the distinction between dividends and interest (what most people mean by “income”) and withdrawals of capital. Cash flow would include both.
Dan, Great review. I am planning to use VRIF to supplement my income. Does it make sense to add VRIF to the MULTI-ASSET-CLASS in the CCP-Rebalancing-Master Table and balance my total portfolio accordingly. I used the table to calculate the class percentages. Also why do you not recommend Corporate bonds VCB in the fixed asset mix for better diversity and growth potencial?
Ticker Fixed Income Canadian Equities U.S. Equities Int’l Equities Emerging Markets
VRIF 50.00% 9.00% 18.0% 22.00% 1.00%
How does BMOś ZZZD Tactical Dividend Sleep at Night ETF compare to VRIF?
This ETF seems a bit heavy with bonds. I think of buying bonds for portfolio diversification the same as drinking coffee while I’m trying to get drunk Besides, in a TFSA, my understanding is that there would be no way to recapture any US withholding tax as the tax treaty was set up before TFSA’s were invented. That was a question.
@Lloyd D: There is no way to recapture foreign withholding taxes in TFSA, period, no matter what fund you use.
Hey Dan,
Thank-you for your excellent review.
I am in retirement (63) with a collection of index ETF’s (RRSP 60/40) and am thinking about moving everything to IBAL. I also have a 5 yr GIC ladder to cover all expenses.
My thoughts are to put IBAL in at RIF at 65 (to claim the yearly 2K pension credit) and then sell units as needed to cover the mandatory withdrawal requirements.
The other option is to put everything in VRIF in an RIF, but I’ll need to sell units anyway to get above the 4% distribution.
Am I missing something?
@Gord: Thanks for the comment. I agree that VRIF is not inherently superior to other asset allocation ETFs in a RRIF, because in both cases you need to manually sell units to meet the minimum withdrawal requirements. The predictable monthly distribution can be very convenient in a taxable account, but it’s much less useful in a RRIF.
In an RRIF, I thought you could withdraw the money as a portion of the fund and not have to sell any units to meet the minimum withdrawal requirements. So if you were 72 and needed to withdraw $16,200, couldn’t you just withdraw that portion of the fund, and then withdraw your 4% in an unregistered account and/or TFSA?
@CZ Moran: You could do what you describe, i.e. make an in-kind withdrawal of VFRIF units from a RRIF to a non-registered account. I’m not sure your brokerage will allow in-kind transfers from a RRIF to a TFSA. In any case, I suppose that would be fairly easy to manage in the sense that you would hold the same ETF in your RRIF and your non-reg, so you would be able to maintain a consistent asset allocation.
Hi Dan, I just finished your “Reboot” book – excellent book! My wife and I just sold our house and have around $450K to put into a non-registered account. We have already topped up our TFSA’s so I’m thinking about VRIF for that as it will give us more than enough income to supplement our current income.I do want to convert our TFSA’s to a single ETF. I was thinking about VCNS as we don’t need these funds currently. We are in our early 70’s so we also have income from our RIF’s. Do you think VCNS is a good option?
@Norman Lee: Thanks for the comment, and for comment! Unfortunately I cannot comment on whether a specific ETF is appropriate for you. VCIP is a perfectly good ETF if you’re looking to hold 60% bonds and 40% stocks, but whether it’s right for you depends on many factors.
As a general rule, if you are in retirement and you have adequate cash flow from your RRIF, non-registered account and government benefits, you may not need the funds in your TFSA at all, at least not for many years. If that’s the case, it might make sense to hold a more growth-oriented ETF in the TFSA and compensating by holding more conservative assets in the accounts you are actively drawing down.