Jul 072015
 

Deciding which accounts to hold different assets in

Should you put stocks in your RRSP or TFSA? What about fixed income like bonds? This post will answer these types of asset location questions. Readers should already be somewhat familiar with tax advantaged accounts such as the RRSP, and regular taxable accounts.

The importance of asset location

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 subject to different tax 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. 😉

asset location for investment efficiency

In an ideal world we would hold all our investments inside tax advantaged accounts such as a TFSA or RRSP. However some people have more investments than what their tax advantaged accounts will hold. If that’s the case then investment income that is 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 would follow.

If you only use RRSP and TFSA:

  • RRSP for interest producing investments and U.S. dividend paying stocks.
  • TFSA for everything else.

If you have RRSP, TFSA, and a non-registered account:

  • RRSP for interest producing investments and U.S. dividend paying stocks.
  • Non-registered accounts for Canadian dividend paying stocks and preferred shares.
  • Everything else can go into the TFSA.

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 asset location 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 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 will not be 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 we hold U.S. stocks in a Canadian mutual fund or ETF, we will need to pay the unrecoverable 15% withholding tax on the dividends.
  • 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.

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://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

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Random Useless Fact

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

15-07-screw-driver-torque-wrench-fact

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Finance Journey
07/07/2015 6:56 am

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
07/07/2015 8:36 am

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
Kevin
07/07/2015 10:34 am

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

W
W
07/07/2015 12:54 pm

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
Giselda
07/07/2015 1:59 pm
Reply to  W

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
W
07/08/2015 8:51 am
Reply to  Giselda

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
Giselda
07/07/2015 1:45 pm

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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[…] Best Investment Vehicles for Different Types of Investments by Freedom Thirty Five Blog – great and simple way to explain Canadian investment vehicles. Very informative for all levels of knowledge […]

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[…] Thirty Five Blog breaks down the tax efficiency of holding various financial instruments in different account types (RRSPs, TFSAs, […]

Potato
07/10/2015 7:19 pm

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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[…] For all the Canadians out there — where to hold what, in your RRSP, TFSA and Margin accounts […]

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12/03/2015 8:46 am

[…] RRSP vs TFSA for Tax Efficiency […]

zorrocket
12/07/2015 1:01 pm

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.… Read more »

Patrick
Patrick
01/11/2018 5:27 pm

What an awesome chart! I don’t think I have seen this done anywhere else kudos to you. I have one comment based on the oft recommended ‘hold dividend paying securities in non- registered accounts’. Perhaps obvious to most but if you bought deep value plays on dividend securities when all you had saving room for was an RRSP ….don’t sell them and move out -leave them there!!! I continue to reap a 9 % dividend (on my original investment) in Bank of Montreal purchase in 2009 when shares dropped from $100 to $29 (gulp) but dividends were untouched. I probably won’t divest until forced too by age especially since dividends have paid my original investment! Share price has climbed most of the way too but that is a side benefit. (I know there are counter arguments to this method but not if you think of it in the same way as buying a riskier version of a GIC).

Ray G
Ray G
03/13/2018 8:01 am

Great post Liquid, as an individual from Canada just started to build out a Dividend Portfolio and plenty of room in RRSP and TFSA, do you still suggest buying Canadian Dividend paying stocks in non-registered accounts? or maxing out registered accounts first and then use the table you have made?

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03/30/2020 6:32 am

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Aron Conroy
Aron Conroy
05/22/2020 7:14 pm

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