Use My Considerations for Allocating Securities to your TFSA / RRSP / Non-registered Accounts
November 2022
These are just a few considerations when looking at what types of investments should be held in your investment accounts.
RRSP
- If you hold US securities in your RRSP, ensure no withholding taxes are deducted from your dividends in accordance with the Canada-United States tax treaty
- Do not hold other foreign securities in your RRSP where foreign taxes are withheld because you will receive no offsetting tax credit on your tax return. Typical tax withholdings are 15%-25%, and you would need a huge rate of return to offset this reduction. With exchange traded funds, ensure that no such taxes are being deducted within the operation of some funds, and hence are not apparent. When uncertain, hold any funds with foreign holdings outside of the RRSP.
- Check the management fees (MERs) charged by any mutual funds held within your RRSP to ensure you are not overcharged. If the mutual fund is within your own self-managed discount, ensure the fee is lower than the typical Class A fund. For example, an equity or balanced fund typically has an MER of about 2.3%, which includes the 1% fee paid to your individual advisor. If you are not working with an advisor, the MER should be lower for this reason. Similarly, if you are working with a full service broker charging you an additional advisory fee on your account, the mutual funds being sold to you should have lower MERs so that you are not double paying.
- All income received by an RRSP is treated the same for tax purposes – it is all treated like interest. You receive no dividend tax credits and 100% (instead of 50%) of your capital gain will be taxable when eventually withdrawn from the RRSP. If your portfolio diversification allows for it, hold such securities in your non-registered account first. However, there are many other factors to also consider that may not make this practical when looking at your portfolio planning as a whole. For example, while it is better tax-wise to hold interest-bearing securities in your registered accounts, you still need enough fixed income types of securities outside of your RRSP to meet your day-to-day spending needs without needing to sell equities on a regular basis or at a time when the market is down.
- When converting your RRSP to a RRIF, and also when withdrawing the minimum amounts from your RRIF, some financial institutions will allow you to cash long-term GICs early without penalty. This eliminates the need to ensure you have GIC maturities coming due when the withdrawal is made, and may allow you to benefit more from higher interest rates on longer term GICs.
- When you start regular draws from your RRSP/RRIF, think carefully before use of a systematic withdrawal plan unless it is solely from interest-bearing investments. The systematic withdrawal plan is designed to pay the same amount out of your RRSP on a regular basis. This can be a problem if it is drawn from stocks and equity or balanced mutual funds. In retirement especially, you should have 7 to 10 years of fixed income securities in your portfolio from which to draw your regular needs. That way, when the stock market declines, you will not need to be selling off units of your equities faster than you expected. To obtain $1,000 per month from a mutual fund valued at $100 per unit will only require you to sell 10 units per month. However, if the price drops to $50 per unit, you will need to sell 20 units per month, depleting your investment portfolio twice as fast. This is an extreme example, but unfortunately, such a problem can occur gradually without you noticing. Systematic withdrawal plans are fine in a rising market, but not in a declining or volatile market, in my opinion.
- Buying an RRSP will reduce your income used to calculate your Canada Child Benefit, which may increase the benefit.
- Do you have a small balance in a Locked in RRSP created by a transfer from a former employer pension plan? There are certain cases when you can transfer this money to a regular RRSP and avoid future withdrawal restrictions, such as when it is less than one-half of the Maximum Pensionable Earnings for Canada Pension Plan, or when you are in financial hardship. Check this out with your financial planner. (Provincial pension laws may have an impact.)
TFSA
- Hold no foreign securities subject to foreign withholding taxes in your TFSA. You will receive no foreign tax credits on dividends, effectively losing you the benefit of the tax-free status of a TFSA.
- U.S. citizens are required to pay tax on income earned in a TFSA, and in some cases, file extra U.S. tax forms. Consequently, it is usually not appropriate for a U.S. citizen to have a TFSA.
- All income received by an RRSP is treated the same for tax purposes – all income will be fully taxable from an RRSP so you do not receive any extra benefit for dividend tax credits or the 50% tax-free portion of a capital gain. Because these two benefits cut tax costs in about half for many taxpayers, you should consider your investment allocations carefully. Although individual circumstances vary, a rule of thumb is that unless dividend and capital gains income are about twice as high as interest income, it may be better to hold interest-bearing securities in your TFSA. Of course, capital losses in a TFSA are not going to save you any taxes either. Unfortunately, you need a crystal ball to determine your future returns.
Non-Registered Accounts
- U.S. citizens should obtain U.S. tax advice before buying Canadian mutual funds because of special tax elections required.
- If you hold equity investments in a non-registered account, and you make significant donations to charity, you can transfer equities with capital gains directly to the charity. This will eliminate any capital gains taxes and still give you a full donation credit for the fair market value of the security.
- Note that investment counsel fees paid from a non-registered account are tax deductible, whereas they are not from a TFSA or RRSP. Similarly, interest on a loan borrowed to buy securities in a non-registered account is deductible, but not so for other accounts. Borrowing to invest is a very high-risk thing to do – it is one thing to lose your own money, but to lose someone else’s and still need to repay it can hurt a lot. “Catch up loans” for RRSPs (and all investment loans) should be avoided until you get financial advice from an independent and objective planner, i.e., someone not selling the investments and/or making the loan to you.
Blair Corkum, CPA, CA, R.F.P., CFP, CFDS, CLU, CHS holds his Chartered Professional Accountant, Chartered Accountant, Registered Financial Planner, Chartered Financial Divorce Specialist as well as several other financial planning related designations. Blair offers hourly based fee-only personal financial planning, holds no investment or insurance licenses, and receives no commissions or referral fees. This publication should not be construed as legal or investment advice. It is neither a definitive analysis of the law nor a substitute for professional advice which you should obtain before acting on information in this article. Information may change as a result of legislation or regulations issued after this article was written.©Blair Corkum