Help with tax efficiency - portfolio setup

Income tax policy, rules, problems, strategy and software. Property and consumption taxes too.
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Help with tax efficiency - portfolio setup

Post by InvestorNewb » 17 Jan 2013 14:18

Hello,

How would you structure the following funds for Canadian tax efficiency?
  • Vanguard Total Stock Market (VTI)
    Vanguard Total International Stock Market (VXUS)
    Vanguard REIT ETF (VNQ)
With my online broker, Qtrade, I have the following investment accounts available:
  • Corporate USD account (taxable)
    USD TFSA
    USD RRSP
I also have Canadian-equivalents to the 3 accounts above, but given that the securities are in USD, and that my cash is already in USD - I will be using the USD accounts.

Most of my portfolio will be in the corporate account, since I only have so much room in my TFSA/RRSP. I haven't yet decided on asset allocations, but these 3 ETFs will likely make up most of my portfolio.

I've decided to stay out of bonds for now, but plan on adding them as I get older.

Thanks in advance.
My Portfolio: VTI [US], VXUS [Int'l], VNQ [REIT], VCN [Canada] (largest to smallest)

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Re: Help with tax efficiency - portfolio setup

Post by Jungle » 17 Jan 2013 14:41

Rsp if you can, no withholding tax on dividends.

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Re: Help with tax efficiency - portfolio setup

Post by Bylo Selhi » 17 Jan 2013 15:47

Based on withholding taxes, in decreasing degree of desirability for holding US-based investments:
1. RRSP • no taxes withheld on distributions
2. Corporate • taxes withheld on distributions can be partially recovered
3. TFSA • taxes withheld on distributions cannot be recovered

There may be other issues involved, e.g. size of RRSP, but this is a starting point.
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Re: Help with tax efficiency - portfolio setup

Post by InvestorNewb » 17 Jan 2013 20:53

Hello,

I plan on using all of the available space in both my TFSA and RRSP.

Based on this, which of the 3 ETFs do you suggest in which account?

i.e. Corporate USD account (taxable), USD TFSA, and USD RRSP.

Thanks
My Portfolio: VTI [US], VXUS [Int'l], VNQ [REIT], VCN [Canada] (largest to smallest)

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Re: Help with tax efficiency - portfolio setup

Post by DavidR » 17 Jan 2013 23:36

Put the fund that is going to go up the most into the TFSA :wink:

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Re: Help with tax efficiency - portfolio setup

Post by InvestorNewb » 19 Jan 2013 10:24

I'm assuming the REIT fund would be best held in TFSA/RSP?
My Portfolio: VTI [US], VXUS [Int'l], VNQ [REIT], VCN [Canada] (largest to smallest)

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Re: Help with tax efficiency - portfolio setup

Post by AltaRed » 19 Jan 2013 13:10

As DavidR said, it is technically the one that would otherwise attract the most tax payable in the future when you sell it, net of the future value of the withholding tax leakage you will have lost on an annual basis until that time. No one knows that in advance because you do not know which of the 3 will provide you with the highest net return.

That said, you have already been advised that in a TFSA, you will permanently lose the withholding tax paid each year on the income generated by a US domiciled investment. Knowing that, and knowing you have no way of knowing future performance, odds on favourite would be to put the lowest yield one in your TFSA.
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Re: Help with tax efficiency - portfolio setup

Post by patriot1 » 19 Jan 2013 13:16

InvestorNewb wrote:I'm assuming the REIT fund would be best held in TFSA/RSP?
RRSP. There will be no withholding tax on the distributions as noted above. But in a TSFA there will.

Don't hold a US REIT in a taxable account. CRA treats all of the distributions as taxable income even though in the US much of them may be return of capital.

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Re: Help with tax efficiency - portfolio setup

Post by InvestorNewb » 21 Jan 2013 15:07

DavidR wrote:Put the fund that is going to go up the most into the TFSA :wink:
It would be nice to know this in advance, wouldn't it? :)
AltaRed wrote:As DavidR said, it is technically the one that would otherwise attract the most tax payable in the future when you sell it, net of the future value of the withholding tax leakage you will have lost on an annual basis until that time. No one knows that in advance because you do not know which of the 3 will provide you with the highest net return.

That said, you have already been advised that in a TFSA, you will permanently lose the withholding tax paid each year on the income generated by a US domiciled investment. Knowing that, and knowing you have no way of knowing future performance, odds on favourite would be to put the lowest yield one in your TFSA.
Would a Canadian domiciled investment also lose the withholding tax in a TFSA?
patriot1 wrote:
InvestorNewb wrote:I'm assuming the REIT fund would be best held in TFSA/RSP?
RRSP. There will be no withholding tax on the distributions as noted above. But in a TSFA there will.

Don't hold a US REIT in a taxable account. CRA treats all of the distributions as taxable income even though in the US much of them may be return of capital.
Can you explain the term "withholding tax" - I'm a bit confused about what this means exactly.

Thanks
My Portfolio: VTI [US], VXUS [Int'l], VNQ [REIT], VCN [Canada] (largest to smallest)

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Re: Help with tax efficiency - portfolio setup

Post by AltaRed » 21 Jan 2013 16:13

The withholding tax only applies to US (and probably other foreign jurisdiction) domiciled investments held by Canadian residents in taxable, i.e. non-registered, accounts. Basically what it comes down to is that each of the Canadian and US governments want to collect some tax from income earned on investments in their jurisdictions. For example, let's say a Vanguard ETF traded on the NYSE throws off $1000 in income in 2012. The US would like to tax all of that income at their income tax rates, or more importantly, tax some of it rather than nothing because the owner of that ETF is a foreigner, i.e. a Canadian outside the US income tax system. So Canada and the USA negotiated a tax treaty in which the US gets to keep 15% of the income ($150) earned by the Canadian resident on that investment, and then the Canadian resident when filing his own income tax return in Canada can claim a tax credit for what he paid in the USA ($150) as a tax credit against his own tax owing in Canada. The same thing essentially happens (with some other wrinkles Canadian citizens do not have to know about) in reverse for an American resident owning Canadian domiciled investments.

At the same time, both Canada and the USA have registered accounts for their residents, e.g. IRA in USA and RRSP in Canada, which are designed to defer taxes until such time the investments in the registered accounts are withdrawn. In this specific case, Canada and the USA agreed in their tax treaty not to withhold tax from each other for recognized registered accounts (since that defeats the purpose of tax deferment). So that is why there is no withholding tax on Vanguard investments held by a Canadian resident in an RRSP. The TFSA is different. The USA does not recognize the TFSA as a tax deferred vehicle, so they withhold 15% as they would for a standard taxable account. The dilemma for the Canadian though is because the TFSA is a non-taxable account in Canada for Canadian income tax purposes, there is no way for a Canadian resident to re-claim any withholding taxes from investments held in the TFSA, and thus the warnings upthread on this.

So, to answer your first question, the answer to your first question is No. There are not withholding taxes in Canada for Canadian investments held by Canadian residents.

Added: A word of caution. The 15% withholding rate would be 30% if your broker does not have a signed US form called W8-BEN on file from you. The point being, unless you sign a form indicating you are a Canadian and a Canadian resident, the USA will withhold its standard 30% (non-tax treaty) withholding tax rate.

Added2: There is quite a bit of information on this in our very own finiki
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Re: Help with tax efficiency - portfolio setup

Post by InvestorNewb » 21 Jan 2013 21:47

AltaRed wrote:The withholding tax only applies to US (and probably other foreign jurisdiction) domiciled investments held by Canadian residents in taxable, i.e. non-registered, accounts. Basically what it comes down to is that each of the Canadian and US governments want to collect some tax from income earned on investments in their jurisdictions. For example, let's say a Vanguard ETF traded on the NYSE throws off $1000 in income in 2012. The US would like to tax all of that income at their income tax rates, or more importantly, tax some of it rather than nothing because the owner of that ETF is a foreigner, i.e. a Canadian outside the US income tax system. So Canada and the USA negotiated a tax treaty in which the US gets to keep 15% of the income ($150) earned by the Canadian resident on that investment, and then the Canadian resident when filing his own income tax return in Canada can claim a tax credit for what he paid in the USA ($150) as a tax credit against his own tax owing in Canada. The same thing essentially happens (with some other wrinkles Canadian citizens do not have to know about) in reverse for an American resident owning Canadian domiciled investments.

At the same time, both Canada and the USA have registered accounts for their residents, e.g. IRA in USA and RRSP in Canada, which are designed to defer taxes until such time the investments in the registered accounts are withdrawn. In this specific case, Canada and the USA agreed in their tax treaty not to withhold tax from each other for recognized registered accounts (since that defeats the purpose of tax deferment). So that is why there is no withholding tax on Vanguard investments held by a Canadian resident in an RRSP. The TFSA is different. The USA does not recognize the TFSA as a tax deferred vehicle, so they withhold 15% as they would for a standard taxable account. The dilemma for the Canadian though is because the TFSA is a non-taxable account in Canada for Canadian income tax purposes, there is no way for a Canadian resident to re-claim any withholding taxes from investments held in the TFSA, and thus the warnings upthread on this.

So, to answer your first question, the answer to your first question is No. There are not withholding taxes in Canada for Canadian investments held by Canadian residents.

Added: A word of caution. The 15% withholding rate would be 30% if your broker does not have a signed US form called W8-BEN on file from you. The point being, unless you sign a form indicating you are a Canadian and a Canadian resident, the USA will withhold its standard 30% (non-tax treaty) withholding tax rate.

Added2: There is quite a bit of information on this in our very own finiki
Thanks for this detailed explanation - it helps alot. +1

I'm going to check with my broker tomorrow about the W8-BEN form and I will also have a closer look at the finiki page.

My next thought is: I'm sure there are a lot of Canadians who hold US securities in their TFSA accounts - without even being aware of the withholding tax. I gather this doesn't act as much of a deterrent for people who want to make USD investments in their TFSA.

So based on my portfolio above, is this the only flaw that you see as far as taxes are concerned? i.e. That I would be better off holding CAD domiciled funds in my CAD TFSA.

To date, I have only researched USD investment funds - since most of my savings are in USD, even though I live in Canada. If I have more confidence in the US economy in terms of growth in specific sectors, should the 15% withholding tax be a deterrent for me holding USD investments in my TFSA? i.e. if I were to go ahead and purchase VNQ in my US TFSA (in addition to my RRSP, since I want more shares), would it really be a showstopper in the long haul?
My Portfolio: VTI [US], VXUS [Int'l], VNQ [REIT], VCN [Canada] (largest to smallest)

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Re: Help with tax efficiency - portfolio setup

Post by pmj » 21 Jan 2013 22:41

AltaRed wrote:Added: A word of caution. The 15% withholding rate would be 30% if your broker does not have a signed US form called W8-BEN on file from you. The point being, unless you sign a form indicating you are a Canadian and a Canadian resident, the USA will withhold its standard 30% (non-tax treaty) withholding tax rate.
It isn't necessary to be a Canadian, or a resident of Canada. The test is that one is not a US-ian, and not a US resident, eg: http://www.tdwaterhouse.ca/discountbrok ... ?id=515874
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Re: Help with tax efficiency - portfolio setup

Post by AltaRed » 21 Jan 2013 23:35

pmj wrote:
AltaRed wrote:Added: A word of caution. The 15% withholding rate would be 30% if your broker does not have a signed US form called W8-BEN on file from you. The point being, unless you sign a form indicating you are a Canadian and a Canadian resident, the USA will withhold its standard 30% (non-tax treaty) withholding tax rate.
It isn't necessary to be a Canadian, or a resident of Canada. The test is that one is not a US-ian, and not a US resident, eg: http://www.tdwaterhouse.ca/discountbrok ... ?id=515874
Fair enough, but for the purposes of this discussion, the individual is a Canadian resident and I opted to keep the explanation simple.

Added: When filling out a W8-BEN, do not complete the box asking for a US SSN/ITIN should you have a SSN or ITIN. It is optional information and I know from horrible experience this can cause unbelievale headache. Take my word for it.
Last edited by AltaRed on 21 Jan 2013 23:53, edited 1 time in total.
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Re: Help with tax efficiency - portfolio setup

Post by AltaRed » 21 Jan 2013 23:42

InvestorNewb wrote: So based on my portfolio above, is this the only flaw that you see as far as taxes are concerned? i.e. That I would be better off holding CAD domiciled funds in my CAD TFSA.

To date, I have only researched USD investment funds - since most of my savings are in USD, even though I live in Canada. If I have more confidence in the US economy in terms of growth in specific sectors, should the 15% withholding tax be a deterrent for me holding USD investments in my TFSA? i.e. if I were to go ahead and purchase VNQ in my US TFSA (in addition to my RRSP, since I want more shares), would it really be a showstopper in the long haul?
The loss of the withholding tax is the only real flaw having US domiciled investments in your TFSA. If you think you can offset that and more with better performance with US securities/ETFs, then by all means go for it. Ultimately though over time, stock markets, at least in developed countries, tend to regress to the mean, and some day, perhaps years, TSE will/should outperform NYSE for awhile - kind of like a horse race where the horses changing places from time to time. Comparing the DJIA or S&P500 against the TSE over a 20+ year period may be worth some study to put some perspective into this.
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Re: Help with tax efficiency - portfolio setup

Post by InvestorNewb » 22 Jan 2013 09:53

AltaRed wrote:
InvestorNewb wrote: So based on my portfolio above, is this the only flaw that you see as far as taxes are concerned? i.e. That I would be better off holding CAD domiciled funds in my CAD TFSA.

To date, I have only researched USD investment funds - since most of my savings are in USD, even though I live in Canada. If I have more confidence in the US economy in terms of growth in specific sectors, should the 15% withholding tax be a deterrent for me holding USD investments in my TFSA? i.e. if I were to go ahead and purchase VNQ in my US TFSA (in addition to my RRSP, since I want more shares), would it really be a showstopper in the long haul?
The loss of the withholding tax is the only real flaw having US domiciled investments in your TFSA. If you think you can offset that and more with better performance with US securities/ETFs, then by all means go for it. Ultimately though over time, stock markets, at least in developed countries, tend to regress to the mean, and some day, perhaps years, TSE will/should outperform NYSE for awhile - kind of like a horse race where the horses changing places from time to time. Comparing the DJIA or S&P500 against the TSE over a 20+ year period may be worth some study to put some perspective into this.
I plan on holding my investments for the long-term. What if the US dollar goes up by 20% in 30 years from now? Then the withholding tax will seem like peanuts in comparison.

I read an article on Canadian Capitalist and here is a quotation from it:
And the #1 reason? As a long-term investor, I’ll be holding these ETFs for 30 years or longer. At the end of 50 years, $100,000 invested initially in a US-listed ETF will be worth 20 percent more than the Canadian ETF even after paying conversion charges of 1.5% on the initial buy, the final disposition and annual dividend payments. Those tiny MER and tax differences do make a dramatic difference for the long-term investor.
Source: http://www.canadiancapitalist.com/why-i ... sted-etfs/
My Portfolio: VTI [US], VXUS [Int'l], VNQ [REIT], VCN [Canada] (largest to smallest)

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Re: Help with tax efficiency - portfolio setup

Post by adrian2 » 22 Jan 2013 10:05

InvestorNewb wrote:I plan on holding my investments for the long-term. What if the US dollar goes up by 20% in 30 years from now? Then the withholding tax will seem like peanuts in comparison.
It's not quite peanuts, it's around half of your potential "worst/best case scenario" in long term exchange rates.

What if the US dollar goes down by 20% in 30 years? Add insult to injury?

Bottom line, if you have the choice of where to hold a non-zero yield US based security, hold it in your RRSP, not TFSA. If you have no such choice, by all means do not refrain from investing in US based on the withholding tax; after all, EAFE securities suffer from similar problems in all types of accounts, while for Canadian equities you "lose" the DTC in all registered accounts. Grin and bear it, but if you're offered a "free trip to the desert tray" (paraphrasing Larry Swedroe), i.e. no withholding tax from the USA in retirement accounts, just grab it!
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Re: Help with tax efficiency - portfolio setup

Post by InvestorNewb » 22 Jan 2013 11:16

AltaRed wrote:Added: A word of caution. The 15% withholding rate would be 30% if your broker does not have a signed US form called W8-BEN on file from you. The point being, unless you sign a form indicating you are a Canadian and a Canadian resident, the USA will withhold its standard 30% (non-tax treaty) withholding tax rate.
I asked my broker about this, and here is their response:
Withholding taxes are 15% for US company common shares on US stock markets, 30% for foreign company common shares listed on the US stock markets and 39% of US limited partnerships.
So I'm okay then.
adrian2 wrote:It's not quite peanuts, it's around half of your potential "worst/best case scenario" in long term exchange rates.

What if the US dollar goes down by 20% in 30 years? Add insult to injury?

Bottom line, if you have the choice of where to hold a non-zero yield US based security, hold it in your RRSP, not TFSA. If you have no such choice, by all means do not refrain from investing in US based on the withholding tax; after all, EAFE securities suffer from similar problems in all types of accounts, while for Canadian equities you "lose" the DTC in all registered accounts. Grin and bear it, but if you're offered a "free trip to the desert tray" (paraphrasing Larry Swedroe), i.e. no withholding tax from the USA in retirement accounts, just grab it!
I also find it difficult to find Canadian funds with low MERs. i.e. those equivalent to Vanguard's popular US funds. I can contribute the maximum amount to my TFSA, but because my funds are already in USD, there would be fees involved during the exchange if I go with that route.
My Portfolio: VTI [US], VXUS [Int'l], VNQ [REIT], VCN [Canada] (largest to smallest)

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Re: Help with tax efficiency - portfolio setup

Post by adrian2 » 22 Jan 2013 12:41

InvestorNewb wrote:I also find it difficult to find Canadian funds with low MERs. i.e. those equivalent to Vanguard's popular US funds. I can contribute the maximum amount to my TFSA, but because my funds are already in USD, there would be fees involved during the exchange if I go with that route.
You can exchange CAD<->USD for peanuts using Norbert's gambit.
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Re: Help with tax efficiency - portfolio setup

Post by InvestorNewb » 24 Jan 2013 19:07

Hello,

To follow-up with my original post, I am posting a draft of my portfolio below:

Vanguard Total Stock Market (VTI, 55%)
Vanguard Total International Stock Market (VXUS, 20%)

^ These ETFs will be held in my Corporate USD account (taxable).

MSCI Canada Index ETF (VCE, 5%)

^ This ETF will be held in my CDN TFSA.

Vanguard REIT ETF (VNQ, 20%)

^ This ETF will be held in my USD RRSP.


Some final questions:

- Do you think VNQ is best held in my USD RRSP? Would there be a difference in holding VNQ in my USD RRSP vs. holding the other US funds like VTI and VXUS in the same account?
- For my CDN TFSA, I'm debating between VCE and VDY. VDY is high dividend yield, and given that there is no withholding tax on the dividends that are generated by these ETFs, I'm thinking that VDY might be a better option.
- Overall, what do you think of my portfolio from a tax perspective, but also in general?

Thanks
My Portfolio: VTI [US], VXUS [Int'l], VNQ [REIT], VCN [Canada] (largest to smallest)

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Re: Help with tax efficiency - portfolio setup

Post by ig17 » 24 Jan 2013 20:32

Have you bought any funds yet? Or is it still just a draft?

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Re: Help with tax efficiency - portfolio setup

Post by InvestorNewb » 24 Jan 2013 20:53

ig17 wrote:Have you bought any funds yet? Or is it still just a draft?
Still a draft... suggestions welcome.
My Portfolio: VTI [US], VXUS [Int'l], VNQ [REIT], VCN [Canada] (largest to smallest)

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Re: Help with tax efficiency - portfolio setup

Post by ig17 » 24 Jan 2013 21:52

You joined the forum on Oct 8. You posted your first portfolio draft on Oct 22. Your first draft included VTI and VXUS. Here's what they did since Nov 1, in less than 3 months:

VTI: +6.58%
VXUS: +7.79%

You missed a very powerful market move while you researched your "perfect" portfolio.

I don't mean to rub salt in the wounds. There is a lesson to be learned here. Being invested is more important than being tax-optimal. Missed gains dwarf potential tax savings. Remember, no portfolio is perfect, because we don't know how the future will unfold. You are allowed to make changes as you go. Beware of Paralysis by Analysis (it can be a real issue for analytically inclined DIY investors).

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Re: Help with tax efficiency - portfolio setup

Post by Bylo Selhi » 25 Jan 2013 07:43

ig17 wrote:There is a lesson to be learned here.
What would be the lesson if VTI and VXUS had dropped in value by 7% ? ;)

BTW I agree with you generally about the virtue of investing when you have the money. I'm just pointing out an equally likely 3 month outcome that helps to explain why people are hesitant to do it.
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Re: Help with tax efficiency - portfolio setup

Post by InvestorNewb » 25 Jan 2013 08:20

ig17 wrote:You joined the forum on Oct 8. You posted your first portfolio draft on Oct 22. Your first draft included VTI and VXUS. Here's what they did since Nov 1, in less than 3 months:

VTI: +6.58%
VXUS: +7.79%

You missed a very powerful market move while you researched your "perfect" portfolio.

I don't mean to rub salt in the wounds. There is a lesson to be learned here. Being invested is more important than being tax-optimal. Missed gains dwarf potential tax savings. Remember, no portfolio is perfect, because we don't know how the future will unfold. You are allowed to make changes as you go. Beware of Paralysis by Analysis (it can be a real issue for analytically inclined DIY investors).
I'm happy I didn't go with that first draft because I was all over the place... with SLV, TIPS, and bonds in my portfolio. Also, in November/December, all we kept hearing about on the news was the fiscal cliff. I know we're supposed to tune out the noise, but this is not easy for a first time investor. I do regret not getting in earlier, but as Bylo points out, it could have just as easily gone the other way.
Last edited by InvestorNewb on 25 Jan 2013 08:29, edited 1 time in total.
My Portfolio: VTI [US], VXUS [Int'l], VNQ [REIT], VCN [Canada] (largest to smallest)

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Re: Help with tax efficiency - portfolio setup

Post by ig17 » 25 Jan 2013 08:21

Bylo Selhi wrote:What would be the lesson if VTI and VXUS had dropped in value by 7% ? ;)
The lesson would be, that no matter how "perfect" your portfolio looks on paper, you can still lose money in the market. ;)

Damn, I would make a good politician! :D

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