By Dale Roberts, CuttheCrapInvesting
Special to the Financial Independence Hub
Should you pay attention to withholding taxes on dividends? What about about capital gains vs dividend income? Should tax considerations trump asset allocation and your risk tolerance level? I get many questions with respect to taxes and ETFs. I will suggest that you do not let taxation and withholding taxes on US and International dividends drive the bus.
Keep in mind that I am not a tax expert. When in doubt have a chat with your accountant or Certified Financial Planner. I form my opinion based on the study of asset allocation models. And I’ll also largely base the opinion after reading what the qualified experts have to say. I also make it a hobby to pester several portfolio managers and investment firms on a regular basis.
Should we worry about what goes where?
Taxes and ETFs and that TFSA question. A reader and friend recently asked if he should build the TFSA in the most tax-efficient manner? After all, in a TFSA we lose the withholding taxes on US and International dividends. There is often more dividend tax efficiency in taxable accounts thanks to tax credits. The most efficient account type for US stocks and US ETFs in a US dollar RRSP account.

Does that mean we should only hold our US equities in our RRSP account?
Justin Bender of the Canadian Portfolio Manager blog constructed a wonderful post on the most tax efficient ETF Portfolio. Here’s how that tax efficient portfolio looked in the end.

Of course this is ridiculous as Justin would point out. Perhaps even shading the portfolio to any great degree does not make sense as well.
Don’t let taxation drive the asset allocation bus
In the above example the tax considerations determine the asset allocation. That in turn will determine the risk level and the ‘expected’ returns for each account type. You might get tax efficiency but no total returns in your taxable account. US stocks might tank and you get negative returns for an extended period in your RRSP account. That TFSA account has a Canadian home bias that so many advisors and financial planners would deplore. We still need those Canadian and US and International equities to ‘protect’ each other.
Of course the above portfolio example does not take into account the more important retirement funding scheme. aka the financial plan. We may need the TFSA account to work just as hard as the RRSP account. On the flip side, the financial plan may call for a quicker draw down of RRSP assets so that the retiree can delay CPP and OAS. That would require an RRSP portfolio at a lower risk level. Those are greater considerations.
It’s tax free after paying withholding taxes
And after tax returns in ETFs can get tricky. Here’s a great article in Advisor’s Edge. Continue Reading…