This is a part of the Investing Series.
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This is going to get tricky because it depends on what you buy and where you decide to hold it, but I am going to try and give you a structured overview of tax advantages in each account.
Every Canadian should have 4 Main Accounts:
I’ve listed them in order of maxation:
- Registered Retirement Savings Plan (RRSP)
- Tax-Free Savings Account (TFSA)
- Investing Accounts (Non-Registered / Margin Account)
- High-Interest Savings Account
*Maxation = A new word I invented to tell you which ones you should max out first. You like?
1. Registered Retirement Savings Plan (RRSP)
Registered Tax Deferred account
Max out the money in this one FIRST.
It is the best deal out of all the 4 accounts because of its special tax-deferred status and tax-treaty powers with the U.S.
HOLD IN THIS ACCOUNT:
- Any U.S. individual stocks — you will not pay U.S. withholding taxes under the U.S.-Canada Tax Treaty
- Any U.S. index funds — you will not pay U.S. withholding taxes under the U.S.-Canada Tax Treaty
- Any mutual funds (index funds) — let them grow since you can’t touch the money until you’re 65 anyway
- Any exchange traded funds (ETFs) (index ETFs) — ditto; let them grow slowly since you can’t touch the money
DO NOT HOLD IN THIS ACCOUNT:
- High-Interest Savings or Cash / Guaranteed Investment Certificates (GICs) — This is a real waste of the account*
- Any stock for capital gains — only 50% of profits are taxed so they’re better in a TFSA or Non-Registered account
- Any stocks for dividend investing — you get a really sweet deal with dividends in terms of taxation outside!
*Invest the money. PLEASE. Invest it!!
Don’t put it just in cash, savings or GICs.
You’re just wasting a perfectly awesome tax-deferred account in doing so, and probably losing money just to inflation to boot.
2. Tax-Free Savings Account (TFSA)
Registered Tax Sheltered account
Max out the money in this one SECOND because while it isn’t as awesome as the RRSP for tax implications, it is still better than a Non-Registered account.
HOLD IN THIS ACCOUNT:
- Any Mutual Funds (Index mutual funds)
- Any ETFs (Index ETFs)
- Any Canadian stocks for capital gains or dividends
- Any U.S. stocks for capital gains — You have to pay a withholding tax of 30% but can get it reduced to 15% with a W8-BEN form as well as getting a tax credit for it (see below)
DO NOT HOLD IN THIS ACCOUNT:
- High-Interest Savings or Cash / Guaranteed Investment Certificates (GICs) — This is a real waste of a tax-sheltered account
CONSIDER THE IMPLICATIONS OF: Holding U.S. stocks or index funds that pay dividends
TFSAs are not considered to be “registered retirement accounts” under the Canada-U.S. Tax Treaty, so any dividends earned from U.S. stocks (either in index funds or held individually) are subject to a withholding tax of 30%.
You can get that U.S. withholding tax on your U.S. dividends down to 15% and then apply for a tax credit when you do your taxes.
See below for note on W8-BEN forms and filing for your year-end foreign tax credits.
3. Investing outside of RRSP / TFSA
Non-Registered, meaning it is NOT tax sheltered/deferred
You can put any money you want in this account that isn’t already in your High-Interest savings account for emergencies, day-to-day bills and the like.
HOLD IN THIS ACCOUNT:
- Any Mutual Funds (Index mutual funds)if you HAVE maxed out your RRSP with them
- Any ETFs (Index ETFs) if you HAVE maxed out your RRSP with them
- Any stock for capital gains — You only pay taxes on 50% of your capital gains (profits) and can claim the capital losses
- Any stock for dividend investing — For Canadian stocks, you get a sweet deal with dividends in terms of taxation
CONSIDER THE IMPLICATIONS OF: Holding U.S. stocks or index funds that pay dividends
TFSAs are not considered to be “registered retirement accounts” under the Canada-U.S. Tax Treaty, so any dividends earned from U.S. stocks (either in index funds or held individually) are subject to a withholding tax of 30%.
You can get that U.S. withholding tax on your U.S. dividends down to 15% and then apply for a tax credit when you do your taxes.
See below for note on W8-BEN forms and filing for your year-end foreign tax credits.
- Questrade: Use my Questrade referral link for $50 in free trades.
And finally this is the last account you should have:
4. High Interest Savings Account
Non-Registered, meaning it is NOT tax sheltered/deferred
You should have a high-interest savings account to hold cash for emergencies and daily banking.
This is where you should hold:
- Cash
- Guaranteed Investment Certificates (GICs)
- Bonds
..not in your RRSP or TFSA.
UPDATE – September 15th 2014
You should really take the time to read the comments, but just in case you’re lazy, Reader Hemgi wrote an excellent strategy for investing in the comments that I think you should all read:
My sequence of investment is the following:
1. Pay any debt that has an interest rate greater than your ROI.
2. Maximized TFSA – use it before government reduce the annual increase of $5500 or eliminate the rights to carry over what has not been used.
3. Pay your Mortgage
4. RRSP if your marginal is greater than 40%, otherwise you gonna pay more tax when you will cash it. It may be interesting to transfer money from your TFSA to RRSP on December is your income is high.
5. Non registered account.
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Psst: If you don’t already have a Tangerine account…
Use my Tangerine referral ID: 32726976S1 to get $50 for free (I get $50 too)
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U.S. Stocks and Index Funds Note for Foreign Investors
(…like for us Canadians)
You do not need to do the following for an RRSP or Registered Retirement Income Fund (RRIF) account because it is tax-free under the U.S.-Canada Tax Treaty.
1. Immediately fill out a W8-BEN form to lower dividend taxes from 30% to 15%
If you are also a foreign investor (eg. not an American citizen), you should contact your bank / brokerage and fill out a Form W-8BEN, Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding.
The IRS withholds 30% (as a tax) on U.S. stocks and index funds that pay out dividends, even on foreign investors.
You can get this reduced (potentially) down to 15% if you fill out that W-8 BEN.
It has to be a form requested by your brokerage or bank (e.g. TD Bank), so I suggest contacting them and finding out how to submit this information to the IRS.
Otherwise, you’re paying extra U.S. taxes (and letting them use 15% of your money for free) on your dividends earned for nothing during the tax year.
With Questrade (where I now hold most of my investments in index fund ETFs with the occasional stock here and there), I contacted them about this and they wrote back saying:
The W8-BEN form is not required to be completed by individuals to have the withholding tax rate adjusted.
This is because only a valid ID that displays a Canadian address can be used to update the rate. All that you would be required to do is submit to us a copy of your valid Canadian Drivers license for us to adjust your with-holding tax rate.
Done.
2. File for a foreign tax credit on your year-end taxes
When you go to do your taxes, fill out Line 405 – Federal foreign tax credit with Form T2209 so that you claim that remaining 15% you have paid in foreign tax credits.
If you are with Questrade, you can find these foreign taxes paid in Questrade by doing the following:
- Click on the “My Account”
- Then on “Account Activity”
- Select your account (Margin or TFSA) to see your dividends and taxes withheld
