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.

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