Retail investors are bombarded with investment advice from today’s media of which most relates to before-tax investment returns. We, however, live in an after-tax world. This is why we need to view tax efficiency and investment decisions together.
In this post, I touch upon the importance of allocating investments in the most tax-efficient manner. This is because tax implications will have a material impact on the capital available for:
- retirement; and
- estate planning purposes.
Ultra-high-net-worth people spend the money and time planning their investments to maximize investment returns and minimizing taxes. Does it not make sense that everyone should also do this?
The following simple example reinforces the need to consider tax efficiency and investment decisions at the same time.
NOTE: I am a Canadian resident so my example uses accounts available to Canadian residents. Adapt this example to meet your circumstances.
Suppose you have an investment portfolio with a total value of $X with the following allocation:
- Registered Retirement Accounts (RRSPs, LIFs, RRIFs): 20%
- Non-Registered Accounts (taxable): 60%
- Tax Free Savings Accounts (TFSAs): 20%
In addition:
- exposure is primarily to US companies with minimal exposure to Canadian and international companies;
- some holdings distribute no dividend;
- several holdings distribute a dividend but the dividend yield is minimal;
- dividends from US holdings incur tax at the highest marginal tax rate if held in a taxable account; and
- there is a non-recoverable 15% dividend withholding tax on any dividend income from US investments within non-registered accounts and TFSAs.
By investing in companies where the majority of the long-term investment return is likely to come from capital appreciation, any tax liability can be deferred until such time as shares are sold. Depending on your circumstances, this can be decades.
To the extent possible, consider holding US shares with attractive dividend yields in your RRSP. This is because under the Canada-US Tax Treaty the US government levies no withholding tax on the dividends.
Canadian stocks that distribute a dividend receive a dividend tax credit. By holding these stocks in a taxable account, it is possible the result will be no tax to a tax rate well below your top marginal rate. You should, therefore, hold your Canadian investments in a non-registered account where possible.
The income and capital gains relating to securities held in a TFSA are sheltered from tax. Dividends received from US holdings within a TFSA, however, incur the 15% non-recoverable dividend withholding tax.
If you have US holdings that distribute no dividend, you can achieve a major tax deferral simply by holding such shares in your taxable account until the time of sale. This is why it typically makes more sense to hold shares in high growth companies in a taxable account.
Do NOT hold these shares in your registered retirement accounts. This is because we must inevitably withdraw funds from these registered accounts. When we withdraw funds from such accounts, we are converting the low tax rate on the realization of a capital gain to our top marginal tax rate.
Several years ago, I made a conscious decision to minimize my exposure to Canadian companies because I envisioned superior long-term investment returns from US companies.
As a result, only ~7% of our total portfolio was Canadian company exposure when I completed my 2024 Year End FFJ Portfolio Review. Our exposure to Canadian companies is now less than at year end because on January 3, 2025, I sold shares in The Royal Bank of Canada (RY.to) as part of our Registered Retirement Savings Plan meltdown strategy.
Given my minimal exposure to Canadian companies, I have exposure to US companies within retirement accounts, taxable accounts, and TFSAs.
Several years ago I converted a meaningful amount of CDN $ to USD $ when they were close to par. The conversion rate has since deteriorated to CAD $1.43 = USD $1. Deciding whether to convert CDN $ to USD $ at the current FX rates adds a whole new level of complexity in the investment decision making process.
Final Thoughts
Investing in Company X within a non-taxable account versus a taxable account can have considerable positive or negative tax implications. We live in an after-tax world, and therefore, tax efficiency and investment decisions should be analyzed together!
Steer clear of anybody who purports to be a ‘financial planner’ who does not provide advice from an after-tax perspective.
I wish you much success on your journey to financial freedom!
Note: Please send any feedback, corrections, or questions to [email protected].
Disclaimer: I do not know your circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your research and due diligence. Consult your financial advisor about your specific situation.
