Jul 072015
 

Determining which accounts (Tax Free, Retirement, or Taxable) to hold different investment types in

Should you put stocks in your RRSP or TFSA? What about fixed income like bonds? This post will answer these types of questions. It’s assumed the reader is already familiar with the TFSA, RRSP, and regular taxable accounts.

There are two parts to every investment decision we make; the investment itself, and the type of account to hold that investment in.

Asset allocation helps to spread out our risk so we don’t put all our eggs in one basket. But asset location is also important because different types of investment incomes are taxed at different rates. We can hold our investments in special tax advantaged accounts to shelter our profits so we don’t pay more tax than we have to. 😉

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In an ideal world all of our investments would be bought inside tax advantaged accounts such as a TFSA or RRSP. There’s little reason to use a non-registered (taxable account) if there is still contribution room remaining in our tax free or registered retirement accounts. However its possible to purchase more investments than what our tax advantaged accounts will hold. If that’s the case then investment income that is typically taxed at higher rates should take priority inside a TFSA or RRSP. So with that in mind let’s get down to the nitty-gritty. 🙂

Which Investment Vehicles to use: TFSA, RRSP, or Non-Registered

Where is the best place to put stocks, bonds, mutual funds, and ETFs? Should they go in an RRSP or a TFSA? There is no categorically correct answer but here are some general guidelines that I follow.

  • Use RRSPs for interest producing investments and U.S. dividend paying companies.
  • Use non-registered accounts for Canadian dividend paying companies and preferred shares.
  • Use TFSAs for everything else.

For a deeper look, below are two charts that go into specifics. The first chart shows how different types of investment income is taxed in different kinds of accounts for someone in the 31% marginal tax bracket. The second chart suggests the best accounts to buy different types of specific investments in. 😀

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Additional notes to consider:

  • If we hold U.S. dividend stocks in a taxable account we’ll pay the 15% U.S. withholding tax off the top. But we can claim a foreign tax credit on our tax returns to recover some or all of this amount. However we’ll pay tax at our marginal rate on the full amount of the U.S. dividend. The net result is that U.S. dividends held in a non-registered account will be taxed at the same rate as interest income.
  • Dividend income from U.S. dividend stocks in a Tax Free Savings Account (TFSA) is also subject to the 15% withholding tax, however this tax is non-recoverable. But the remaining dividend and any capital gains is not taxed.
  • Dividend income from U.S. stocks in an RRSP are exempt from the 15% withholding tax. But this only applies if we directly hold a stock or ETF traded on a U.S. exchange. If the U.S. stocks are held in a Canadian mutual fund or ETF, we will need to pay the unrecoverable 15% withholding tax on the dividends.
  • Keep in mind that although many investment incomes are tax efficient while being held in an RRSP, any money withdrawn from the RRSP or RRIF later on will be subject to income tax at the full marginal rate and could trigger claw-backs for income tested government benefits like OAS.
  • Tax efficiency should not be the only factor when deciding which account to put an investment into. Simplification of record keeping, personal financial situation, risk tolerance, and retirement goals all have to be considered.
  • For most intents and taxation purposes RESPs behave the same way as TFSAs. RRIFs and LIRAs behave similar to RRSPs.

My research isn’t perfect. So if I’ve missed something or made a mistake please let me know in the comments section. And much gratitude for all the bloggers, journalists, and writers in the credits below that have made it possible for me to put this page together.

Sources of information:
http://www.taxtips.ca/taxrates/canada.htm
http://www.theglobeandmail.com/globe-investor/advisers-view/what-to-put-in-your-tfsa-whats-best-for-an-rrsp/article21556869/
http://www.moneysense.ca/retire/delectable-dividends/
http://canadiancouchpotato.com/2010/03/05/put-your-assets-in-their-place/
http://www.theglobeandmail.com/globe-investor/investor-education/what-return-of-capital-means-to-fund-investors/article547291/
http://canadiancouchpotato.com/2013/12/09/ask-the-spud-when-should-i-use-us-listed-etfs/
http://www.taxtips.ca/personaltax/investing/taxtreatment/investmentaccounts.htm
http://wheredoesallmymoneygo.com/investor-advisory-alert-year-end-tax-distributions/
http://www.theglobeandmail.com/globe-investor/advisers-view/what-to-put-in-your-tfsa-whats-best-for-an-rrsp/article21556869/
http://canadiancouchpotato.com/2010/03/05/put-your-assets-in-their-place/
http://www.td.com/to-our-customers/tdhelps/#psce|cid=871|lid=1|tid=001|vid=a025febd5
http://www.moneysense.ca/invest/asset-ocation-everything-in-its-place/
http://www.greaterfool.ca/2015/06/21/the-deceivers-2/

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Random Useless Fact

Screwdriver handles are shaped so that a wrench can slide over them for more torque.

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23 Comments on "The Best Accounts to Put Different Types of Investments In"

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Finance Journey
Guest

Good information Liquid,

I would like to add one more point. You can hold U.K based stocks in TFSA accounts and there will be no withholding tax for them. If you hold them in non-registered accounts, then it will be taxed at the marginal rate but no withholding tax.

I have Unilever plc (NYSE:UL) in my TFSA and I receive full dividends (minus $0.10 for fee)

Cheers,

Janine
Guest

This is amazing! I’m sharing this with everyone! I know a lot about tax, but anyone of any age could understand this color coded chart!

Kevin
Guest
Kevin

Thorough and simplified. This will be a handy reference guide.

W
Guest
W

Nice summary.

US and foreign capital gains only have half the gain taxed at the marginal rate so it should be 16% not 31%. Also, US master limited partnerships have a withholding tax equal to the highest federal rate (39.6%) which isn’t recoverable in a TFSA or RRSP.

Lastly, I’m splitting hairs a bit, but for capital gains half the gain is taxed at the full marginal rate, not all the gain taxed at half the marginal rate. The distinction’s important because it highlights one of the best things about capital gains, that only half the gain is included giving a lot more room in each tax bracket. In BC, if I earn $150k in income I’m taxed at an average rate of 30.2%. If I make $150k in capital gains I’m taxed at an average rate of 10.6%, almost a third of the rate.

Giselda
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Giselda

If you are correct about the huge tax on master limited partnerships, then Liquid’s recent purchase of BEP.UN in his TFSA may qualify as his biggest investment blunder to date…Should he move the shares in a taxable account?

W
Guest
W

BEP.UN is a bit of a weird one. From what I can tell, it’s a Bermuda LP that’s treated as a Canadian LP for TSE:BEP.UN and a US LP for NYSE:BEP. As a Canadian holding TSE:BEP.UN you pay the normal 15% withholding tax only on the portion of income derived from the US (roughly a third of the taxable income in 2014). I think if you held NYSE:BEP as a Canadian you’d pay the 39.6% US withholding tax.

Giselda
Guest
Giselda

Is there any tax on a foreign bond ETF held in a TFSA? I know foreign stocks in a TFSA get the dividend withholding tax, but what about a US-domiciled bond ETF held in a TFSA? (for logistical purposes I prefer it in the TFSA; the question is what is the optimal placement for tax purposes).

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Potato
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For dividend payers it’s a bit tricky. In your example of someone in the ~31% tax bracket, they would still prefer to hold them in a TFSA or RRSP over a non-registered. They’re just the first thing you want to put into a non-registered account once the tax-advantaged accounts are full. However, if you’re below ~$44k in income then you may want to keep them in a non-registered account because for low-income earners in some provinces the tax on dividends is negative (though you need to balance that against the capital gains — so high divvy payers with low growth and preferreds fit, but a regular dividend paying stock or broad index may still be better in a TFSA).

If you’re in a higher tax bracket though that “first out” switches (assuming all else is equal about total return): Over ~$105k in income in BC or ~$85k in Ont and dividends attract a higher marginal tax than capital gains.

Going back to that point about assuming returns are equal, the marginal tax on interest income is the highest, but given what savings accounts and GICs are paying, it’s likely that they should go to the front of the non-registered queue.

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zorrocket
Guest

Hi Liquid,

Really enjoy reading about your personal finance journey through your blog. Much easier to relate to than what most other financial blogs offer.

That said, I’m trying to decide something and would appreciate your views:

– My employer offers spending accounts (amount is about $4,000) that I must decide how to allocate.
– It can be allocated to pay for daycare expenses, or put in a TFSA, or in a RRSP
– Both of the latter have to be with RBC, which I’m not thrilled about but I would look to transfer it to another institution asap
– I have the necessary contribution room for both
– My marginal tax rate is 36% (in AB).

Trying to decide how to allocate:
– my understanding is that if I go with the TFSA, or use the money towards daycare, just over a third of it will be gone in taxes now, so the tax on that money is paid, and it is not “stuck” in an RRSP.
– if I go with the RRSP, I won’t “forfeit” the income tax portion of this amount and therefore get to invest more, but will only get to use this money later.

What would you do?

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