# Portfolio allocation question



## indexxx (Oct 31, 2011)

I copied this from Taxtips.ca. It's ranking the best places to hold various investments; I'm confused about an RRSP being the best place for US corporations. Would you not prefer them in a non-registered account, for the favourable capital gains tax treatment?

Shares in US corporations:

1.RRSP/RRIF because no dividend tax credit, and no withholding tax
2.non-registered, because all or part of the withholding tax can be recovered through the foreign tax credit
3.TFSA - there will be withholding tax that cannot be recovered

I have a large chunk of money in a private-brokerage mutual fund RRSP, but want to ditch the high MER and utilize the money for stocks or index funds. I'd like to do an in-kind transfer to Questrade, sell the MF, and invest as I see fit. Is it better to use this sum to buy US stock in my RRSP and use cash for index funds in a non-registered account, or the other way around?


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## andrewf (Mar 1, 2010)

Companies that do not pay dividends (or only small dividends) would be better in a taxable account. Actually, given that the dividend yield on the S&P 500 is only about 2%, most of the expected return is in the form of capital gains. I could see it being more efficient to hold US equities in a taxable account depending on your circumstances.


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## indexxx (Oct 31, 2011)

andrewf said:


> I could see it being more efficient to hold US equities in a taxable account depending on your circumstances.


That's what I thought as well. I wonder why the article said otherwise?


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## Donny (Dec 14, 2011)

Taxtips.ca is correct that it's best to hold it in your RRSP. The only reason why it would be better to hold it in a taxable account rather than an RRSP is if you expect to have a much lower effective tax rate on withdrawal than when you put it in.

Here's an example with numbers:

You have $1000 of pre-tax money which you are deciding to invest in a US stock/ETF either in an RRSP or in a taxable account. It pays absolutely no dividends, it increases in value at 10% per year, and your tax rate on deposit and on withdrawal will be 30%.

Option 1, RRSP: You have $1000 pre-tax, so you invest $1000, earn 10% per year for 20 years and end up with $6727.50 before tax ($1000 * 1.10^20). You withdraw the money and pay 30%, leaving you with $4709.25 available to spend, after tax.

Option 2, taxable: You have $1000 pre-tax, you pay 30% tax immediately and have $700 after tax to invest. You invest $700, earn 10% per year for 20 years and end up with $4709.25 ($700 * 1.10 ^ 20) nominally. However, of that you have $4009.25 ($4709.25 - $700) of unrealized capital gains. You pay tax at the capital gains rate of half, so you pay $601.3875 ($4009.25 * 30% tax * 0.5 because it's capital gains), leaving you with $4107.8625 ($4709.25 − $601.3875) available to spend, after tax.

The situation is even more favorable to the RRSP if the stock/ETF pays any dividends at all, because they will compound faster in the RRSP than in the taxable where you'll have to pay tax every year.


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## andrewf (Mar 1, 2010)

It is always better to use a registered account than a taxable account for any investment, provided you have room. If you are constrained by contribution room, US dollar stocks are not the most important to have in the registered account.


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## indexxx (Oct 31, 2011)

BUT- when you withdraw monies from an RRSP, it is treated as income and therefore you are exposed to clawbacks, thus lowering your total return by the clawback amounts. Are capital gains in a taxable account also counted as income for clawback purposes?

Then there's also this quote, from Canadian Tax Resource:

Tax Tips For Capital Gains

Maximize Tax Efficiency – Keep your capital gains generating investments outside of your registered accounts and your interest generating investments inside your registered accounts.

Dazed and Confused...


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## OhGreatGuru (May 24, 2009)

indexxx said:


> ...
> 
> 2.non-registered, because all or part of the withholding tax can be recovered through the foreign tax credit
> ...


You don't actually "recover" the withholding tax. You are given federal & provincial tax credits for foreign taxes paid, so you will be subjected to something less than double taxation on them.


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## Donny (Dec 14, 2011)

indexxx said:


> BUT- when you withdraw monies from an RRSP, it is treated as income and therefore you are exposed to clawbacks, thus lowering your total return by the clawback amounts. Are capital gains in a taxable account also counted as income for clawback purposes?


Interest income, capital gains, return of capital - there's no distinction in an RRSP or a TFSA. The only thing that matters is the amount you take out.
When you take money out of your RRSP, it doesn't matter how it got there: you are correct that it is treated as income. And you are correct that it exposes you to clawbacks, which effectively increases the rate at which you are taxed.



indexxx said:


> Tax Tips For Capital Gains
> 
> Maximize Tax Efficiency – Keep your capital gains generating investments outside of your registered accounts and your interest generating investments inside your registered accounts.
> 
> Dazed and Confused...


What it means is that if you have a choice of _either_ putting interest generating investments (eg bonds) or capital gains generating investments (eg stocks) in your registered account, you should put your interest investments inside and your capital gains outside.

If you have room in your RRSP/TFSA for all your investments, it is quite likely that you should put all your investments inside. What TaxTips is giving you is the priority - once you don't have enough room, your stocks should be kicked out of your RRSP/TFSA in order to make sure you have enough room for all your bonds.

There's a page that gives a very thorough model of RRSPs, how they work, and their effects. It cleared up a lot of misconceptions I had before: http://www.retailinvestor.org/RRSPmodel.html
It's fairly long, but you see these misconceptions everywhere and it could lead you to make incorrect decisions regarding your RRSP.


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## Soils4Peace (Mar 14, 2010)

If the capital gain investment returns more than twice the return of the interest investment, then it should be first to fill the TFSA room. You need to consider the rate of return as well as the different tax rates for capital gains, dividends and interest.


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## Donny (Dec 14, 2011)

Soils4Peace said:


> If the capital gain investment returns more than twice the return of the interest investment, then it should be first to fill the TFSA room. You need to consider the rate of return as well as the different tax rates for capital gains, dividends and interest.


Unless you're anticipating a change in tax rate, I don't think that's true. My understanding is that the TFSA and the RRSP should be equivalent no matter what the investment return, no matter what the different tax rates for capital gains / dividends / interest.

Could you give an example with numbers?


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## Soils4Peace (Mar 14, 2010)

Donny said:


> Unless you're anticipating a change in tax rate, I don't think that's true. My understanding is that the TFSA and the RRSP should be equivalent no matter what the investment return, no matter what the different tax rates for capital gains / dividends / interest.
> 
> Could you give an example with numbers?


I am talking about different returns for different types of investments. Interest-bearing securities tend to have lower rates of return than stocks. If the rates of return are the same, then the low MITR investment (capital gains) goes to the back of the queue for TFSA or RRSP.

If the MITR does not change going forward, then TFSA beats all because it is not affected by clawback. BTW I had an experience with clawback where I collected EI in the first part of the year, only to find a good paying job in the second half. Not fun.


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## Eclectic12 (Oct 20, 2010)

Soils4Peace said:


> I am talking about different returns for different types of investments. Interest-bearing securities tend to have lower rates of return than stocks. If the rates of return are the same, then the low MITR investment (capital gains) goes to the back of the queue for TFSA or RRSP.
> 
> If the MITR does not change going forward, then TFSA beats all because it is not affected by clawback.
> 
> BTW I had an experience with clawback where I collected EI in the first part of the year, only to find a good paying job in the second half. Not fun.


Hmmm ... if the clawback is included, then the other variables that will affect the situation should also be considered.

For example, say the RRSP contribution is through work with the refund right away. Then the money in the RRSP for investing is the full $1 of income. To invest in the TFSA, the money is after-tax, so for someone in the 30% range, they are really only investing $0.70 in the TFSA.

So what's the impact of having more money growing tax sheltered and then paying tax versus less grow tax free?


Cheers


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## Soils4Peace (Mar 14, 2010)

Eclectic12 said:


> So what's the impact of having more money growing tax sheltered and then paying tax versus less grow tax free?


The impact depends on MITR going in, MITR coming out, and clawback. If the MITRs are the same and the absolute value of clawbacks are the same in both years, then there is no difference, other than fees perhaps.


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## indexxx (Oct 31, 2011)

Eclectic12 said:


> Hmmm ... if the clawback is included, then the other variables that will affect the situation should also be considered.


Exactly- we MUST include the clawback, in order to be realistic with the theory. As the clawback (god, what a horrible word...) is a fact, it must be accounted for when making these investment decisions. So imagine that you ignored or were ignorant of the clawback 25 years prior to retirement, maxed out your RRSP your whole life, then when you start withdrawing it through an RRIF, you discover that it was the worst decision you could have made because you are in fact far behind your potential returns- due to 
A. paying full marginal rate of income tax
B. big clawbacks on your other income sources.

These two factors could wipe out a large percentage of your gains over time, negating the perceived 'benefit' of RRSPs for some people (lower income earners, those whose income rises in later life, etc.) You would have been better off in a taxable account (plus your TFSA of course) for much of your holdings. That's the crux of my initial question when I started this thread; I have a large sum sitting in mutual funds in an RRSP, but want to ditch the mutual fund's high MERs and buy U.S. stocks and index funds- so am I better off doing this within my RRSP, or withdrawing from the RRSP and taking the tax bite now, and then do my investing, growing the capital gains outside in a non-reg account? I am low-income and will likely stay that way.


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## warp (Sep 4, 2010)

Just more tax lunacy from the CRA to complicate our lives.

I've been hearing for years about how they are going to "simplify" our tax system, but of course, as always with the government, the more they do, the worse and more ludicrous it gets.

If the average Canadian cannot understand, or easily fill out his or her tax return, and since it is a legal requirement to do so, then it's just plain wrong.


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## HaroldCrump (Jun 10, 2009)

warp said:


> If the average Canadian cannot understand, or easily fill out his or her tax return, and since it is a legal requirement to do so, then it's just plain wrong.


If you feel that way, you should buy shares of HRB.
Almost 5% yield.
If you can't change the situation, at least profit from it.


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## Eclectic12 (Oct 20, 2010)

indexxx said:


> Exactly- we MUST include the clawback, [ ... ] due to
> A. paying full marginal rate of income tax
> B. big clawbacks on your other income sources.
> 
> ...


There is no simple answer - because key assumptions such as the retirement date or the retirement income level or what makes up the retirement income are going to change the options available, including what makes the most sense. 

Here's a couple examples ...

Retirement age - If one is retiring at 60 and has say a total retirement income of $35K, then there may be an option to pull money out of the RRSP - up to the $66,733 that triggers the OAS repayment or clawback. How will this change the minimum RRIF withdrawals and influence the total retirement income at 65?

Early Withdrawals from the RRSP - Will one's employer allow a sabbatical that is funded from RRSP withdrawals? This also allows a reduction of the RRIF minimums and may reduce the MITR at the time of withdrawal.

Retirement Income - The repayment is trigged by net income, with includes pensions (gov't + private), investments (CG, dividends, interest) as well as RRIF withdrawals. What is the expected investment income at 65? How much will the investment income part go up if the RRSP is cleaned out and shifted to a taxable account? What would the RRSP have grown to by the date that income has to be withdrawn?


Only you can make some reasonable assumptions, run some possibilities, have an idea of whether you will be affected and come up with a plan. Even then - life changes. My dad planned on retiring at 65 but a heart problem resulted in early retirement at 58 - which changed both his retirement income plus his options.


Here's some articles:
http://www.theglobeandmail.com/glob...void-the-dreaded-oas-clawback/article2037894/
http://blog.taxresource.ca/dont-fear-the-oas-clawback/
http://www.milliondollarjourney.com/old-age-security-and-the-oas-clawback.htm


Cheers


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## Eclectic12 (Oct 20, 2010)

indexxx said:


> [ ... ]
> 
> So imagine that you ignored or were ignorant of the clawback 25 years prior to retirement, maxed out your RRSP your whole life, then when you start withdrawing it through an RRIF, you discover that it was the worst decision you could have made because you are in fact far behind your potential returns- due to
> A. paying full marginal rate of income tax
> ...


If by "full marginal rate" you mean the maximum for the federal taxes, it's hard to be in the top rate. Based on this link, for 2012 an income of $132,406 starts the max rate.
http://www.cra-arc.gc.ca/tx/ndvdls/fq/txrts-eng.html

I can see where the RRIF part of one's retirement income can bump up the MITR, especially where one ignored this part when doing tax planning. However, I would think a low-income person would need a large RRSP to end up with that much income. This link says that the minimums range between 4% to 20% of the RRIF value.
http://www.franklintempleton.ca/ca/retail/en/pdf/products/reg_plans/RRIF.pdf


Cheers


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## mrPPincer (Nov 21, 2011)

Hi indexxx, I guess every situation is unique with regards to planning RRSP allocation, but my situation is very similar to yours.

I am low income and plan to stay that way, and am planning to move some of my savings from td e-funds to etfs in the near future for greater diversification.

Im under 50 but in my case it made sense to convert my RRSP into a SDRRIF. This way I can slowly move my investments out, into a non-registered account, in-kind, until by the time I fully retire it will mostly be outside. (Any portion I move out over the minimum amount will be subject to the same 10% withholing tax that a withdrawal from a RRSP would trigger)
If you are considering withdrawing from your RRSP and taking a tax hit now, then the route I took could definitely be something for you to consider.

In regards to where to hold US stocks, it depends partially on how low income you are, or plan to be. 
The first place to hold them for the very low income* is in a registered account, because the 15% with-holding tax that the US keeps from dividends is not recoverable, it can only be used as a write-off against taxes paid, and if you aren't paying income tax on any given year... well, then it's gone.

edit - *(at least in my case)


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## Eclectic12 (Oct 20, 2010)

mrPPincer said:


> Hi indexxx, I guess every situation is unique with regards to planning RRSP allocation, but my situation is very similar to yours.
> 
> I am low income and plan to stay that way, and am planning to move some of my savings from td e-funds to etfs in the near future for greater diversification.
> 
> ...


It's good to hear from someone in a similar situation as the OP with another option (the at 50 SDRRIF). Being in a different category and not needing to investigate - I wasn't aware of this possibility.

A small point that you are probably already aware of but can be confusing to others is the RRSP withdrawal withholding tax. It varies by the amount removed (10% is for a $5K or less withdrawal) and is a down payment against what the actual tax will. 
http://www.milliondollarjourney.com/how-rrsp-withdrawals-work.htm

The full withdrawal amount will be taxed as income but depending on how the total income for that year works out, the 10% may be too much (i.e. refund), too little (i.e. tax to pay) or just right.


Cheers


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## mrPPincer (Nov 21, 2011)

Eclectic12 said:


> A small point that you are probably already aware of but can be confusing to others is the RRSP withdrawal withholding tax. It varies by the amount removed (10% is for a $5K or less withdrawal) and is a down payment against what the actual tax will.
> http://www.milliondollarjourney.com/how-rrsp-withdrawals-work.htm
> 
> The full withdrawal amount will be taxed as income but depending on how the total income for that year works out, the 10% may be too much (i.e. refund), too little (i.e. tax to pay) or just right.
> ...


Thanks for pointing that out Eclectic.

You're right, I didn't think to mention that for RRSP withdrawals, in order to get the lowest RRSP withholding tax, 10% (possibly partially or fully refundable come tax time depending on income), you have to do the withdrawals in amounts of $5,000 or less (you can do multiple withdrawals if you are doing more than 5K)


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## Eclectic12 (Oct 20, 2010)

mrPPincer said:


> Thanks for pointing that out Eclectic.
> 
> You're right, I didn't think to mention that for RRSP withdrawals, in order to get the lowest RRSP withholding tax, 10% (possibly partially or fully refundable come tax time depending on income), you have to do the withdrawals in amounts of $5,000 or less (you can do multiple withdrawals if you are doing more than 5K)


No problem.

In some other posts, people have confused the rrsp withdrawal withholding tax and then more tax due at income tax time as the withholding tax taken was too small based on net income as "the rrsp was double taxed". 

So it is definitely an area of that can lead to confusion.


Cheers


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