Before tax-free savings accounts came along, I invested in stock index funds in my registered retirement savings plan. Now, I realize that these investments do not benefit from favourable tax treatment available for dividends and capital gains in a non-registered account. This makes me think that on an after-tax basis it’s better to hold equities in a non-registered account than in an RRSP. Is my thinking correct?
No. It’s a myth that you’re better off holding stocks in a non-registered account to benefit from the favourable tax treatment of dividends and capital gains. The opposite is true, as I’ll demonstrate in a moment.
The key thing to understand is that the dividend tax credit and 50-per-cent inclusion rate for capital gains don’t eliminate tax. They just reduce it relative to the tax rate on interest and other income.
In an RRSP, on the other hand, there are no taxes on investment gains or income.
I can hear people objecting: “But you pay tax when you withdraw money from your RRSP!” That’s true. But what critics of RRSPs forget is that RRSP contributions are made with pre-tax dollars. When the government taxes your RRSP withdrawals, it’s basically collecting the tax it let you defer originally, plus the implied growth of that tax over time.
Let’s look at an example that compares the returns of two investors, Harry and Sally. Harry chooses to invest in a non-registered account to get the supposed tax savings on dividends and capital gains. Sally follows the conventional wisdom to invest in her RRSP. We’ll assume both investors start with $10,000 before tax and have a constant marginal tax rate of 40 per cent on regular income and 20 per cent for both dividends and capital gains. (These rates are for illustration purposes only.)
Let’s start with Harry. Because he is investing in a non-registered account, he’ll be using after-tax dollars. So, the first thing he needs to do is pay $4,000 of income tax on his $10,000. That leaves him with a net $6,000. Let’s assume he invests the money in a stock that triples in value to $18,000 and pays him $1,000 in dividends over 10 years, for a total of $19,000.
When Harry sells his shares, he’ll owe capital gains tax of $2,400 (20 per cent of $12,000). He will have also paid $200 of tax on his dividends (20 per cent of $1,000). That adds up $2,600 of tax on his investment earnings, leaving Harry with a net $16,400 after tax ($19,000 minus $2,600).
Now, let’s look at how Sally would fare if she bought the same stock in her RRSP. Because she’s investing pre-tax dollars, she gets to put the entire $10,000 into her RRSP. After 10 years, her shares will have tripled to $30,000, and she will have collected about $1,667 in dividends – about 67 per cent more than Harry. Before any taxes are deducted, Sally will have $31,667 in her RRSP.
When it’s time to cash in her shares and withdraw the money, Sally will pay income tax of about $12,667 (40 per cent of $31,667), leaving her with $19,000 after tax ($31,667 minus $12,667). That’s $2,600 more than Harry.
If that number sounds familiar, it’s because Harry paid exactly $2,600 of tax on his capital gains and dividends in his non-registered account, whereas Sally paid no taxes on her investment earnings. As this example illustrates, far from saving tax, non-registered accounts increase your taxes relative to investing in an RRSP.
To repeat, this example assumes a constant tax retirement. But if we assume a lower tax rate when money is withdrawn from an RRSP – as is the case for many retirees – Sally’s advantage would be even greater.
I sold a U.S. stock in a non-registered account for the tax loss and waited 30 days. Now, I want to repurchase the stock in my tax-free savings account. Do I have to exchange the U.S. dollars to Canadian dollars before I put the money in my TFSA, and then exchange the funds back to U.S. dollars to repurchase the U.S. stock?
Currency conversions are your enemy as an investor. Banks typically take a profit of 1 to 2 per cent each time they buy or sell, so converting U.S. dollars into Canadian dollars, and then back again, would be a double whammy. The good news is that, depending on your broker, you may be able to avoid the hassle and expense of currency switching.
There is certainly no legal reason you can’t deposit U.S. dollars directly to your tax-free savings account.
“You can contribute foreign funds to a TFSA,” the Canada Revenue Agency says on its website. “However, your issuer will convert the funds to Canadian dollars (using the exchange rate on the date of the transaction), when reporting this information to us.”
Note that the value of your U.S. dollar contribution, expressed in Canadian dollars, cannot exceed your TFSA contribution room. Overcontributions to TFSAs are subject to a penalty tax of 1 per cent per month on the excess amount.
Now, back to your question. Some brokers make it painless to contribute U.S. dollars to a registered account. For example, my broker, BMO InvestorLine, has a straightforward “move money” feature. I simply choose the account I’m moving money from, specify the currency and choose the destination account.
With some brokers, however, the process is more convoluted. TD WebBroker, for instance, says on its website that contributions cannot be made directly to the U.S. dollar component of a TFSA or registered retirement savings plan. Clients must contribute to the Canadian dollar side of their registered account, then convert the money to U.S. dollars.
Some TD clients use a workaround to avoid currency conversion costs. They purchase a U.S. money-market fund in their non-registered account using U.S. dollars, transfer the fund in-kind to the U.S. side of their registered account, then sell the fund and realize the cash proceeds in U.S. dollars.
Speak to your broker about what options are available. If your broker doesn’t allow direct TFSA contributions in U.S. dollars, ask how it can facilitate a transfer that minimizes or eliminates currency-conversion costs.
TORONTO – Canada’s main stock index was higher in late-morning trading, helped by strength in energy stocks, while U.S. stock markets also moved up.
The S&P/TSX composite index was up 34.91 points at 23,736.98.
In New York, the Dow Jones industrial average was up 178.05 points at 41,800.13. The S&P 500 index was up 28.38 points at 5,661.47, while the Nasdaq composite was up 133.17 points at 17,725.30.
The Canadian dollar traded for 73.56 cents US compared with 73.57 cents US on Monday.
The November crude oil contract was up 68 cents at US$69.70 per barrel and the October natural gas contract was up three cents at US$2.40 per mmBTU.
The December gold contract was down US$7.80 at US$2,601.10 an ounce and the December copper contract was up a penny at US$4.28 a pound.
This report by The Canadian Press was first published Sept. 17, 2024.
TORONTO – Strength in the base metal and technology sectors helped Canada’s main stock index gain almost 100 points on Friday, while U.S. stock markets climbed to their best week of the year.
“It’s been almost a complete opposite or retracement of what we saw last week,” said Philip Petursson, chief investment strategist at IG Wealth Management.
In New York, the Dow Jones industrial average was up 297.01 points at 41,393.78. The S&P 500 index was up 30.26 points at 5,626.02, while the Nasdaq composite was up 114.30 points at 17,683.98.
The S&P/TSX composite index closed up 93.51 points at 23,568.65.
While last week saw a “healthy” pullback on weaker economic data, this week investors appeared to be buying the dip and hoping the central bank “comes to the rescue,” said Petursson.
Next week, the U.S. Federal Reserve is widely expected to cut its key interest rate for the first time in several years after it significantly hiked it to fight inflation.
But the magnitude of that first cut has been the subject of debate, and the market appears split on whether the cut will be a quarter of a percentage point or a larger half-point reduction.
Petursson thinks it’s clear the smaller cut is coming. Economic data recently hasn’t been great, but it hasn’t been that bad either, he said — and inflation may have come down significantly, but it’s not defeated just yet.
“I think they’re going to be very steady,” he said, with one small cut at each of their three decisions scheduled for the rest of 2024, and more into 2025.
“I don’t think there’s a sense of urgency on the part of the Fed that they have to do something immediately.
A larger cut could also send the wrong message to the markets, added Petursson: that the Fed made a mistake in waiting this long to cut, or that it’s seeing concerning signs in the economy.
It would also be “counter to what they’ve signaled,” he said.
More important than the cut — other than the new tone it sets — will be what Fed chair Jerome Powell has to say, according to Petursson.
“That’s going to be more important than the size of the cut itself,” he said.
In Canada, where the central bank has already cut three times, Petursson expects two more before the year is through.
“Here, the labour situation is worse than what we see in the United States,” he said.
The Canadian dollar traded for 73.61 cents US compared with 73.58 cents US on Thursday.
The October crude oil contract was down 32 cents at US$68.65 per barrel and the October natural gas contract was down five cents at US$2.31 per mmBTU.
The December gold contract was up US$30.10 at US$2,610.70 an ounce and the December copper contract was up four cents US$4.24 a pound.
— With files from The Associated Press
This report by The Canadian Press was first published Sept. 13, 2024.
TORONTO – Canada’s main stock index was down more than 200 points in late-morning trading, weighed down by losses in the technology, base metal and energy sectors, while U.S. stock markets also fell.
The S&P/TSX composite index was down 239.24 points at 22,749.04.
In New York, the Dow Jones industrial average was down 312.36 points at 40,443.39. The S&P 500 index was down 80.94 points at 5,422.47, while the Nasdaq composite was down 380.17 points at 16,747.49.
The Canadian dollar traded for 73.80 cents US compared with 74.00 cents US on Thursday.
The October crude oil contract was down US$1.07 at US$68.08 per barrel and the October natural gas contract was up less than a penny at US$2.26 per mmBTU.
The December gold contract was down US$2.10 at US$2,541.00 an ounce and the December copper contract was down four cents at US$4.10 a pound.
This report by The Canadian Press was first published Sept. 6, 2024.
