For most Canadians, sticking to a CAD-listed exchange-traded fund (ETF) is best. Not having to pay currency exchange fees can really save you money over the long run. More brokerages also offer commission-free trading, so you buy and sell to your heart’s content.
There is an exception, though. If you have an investment portfolio of $30,000 or more in a Registered Retirement Savings Plan (RRSP), you could save even more by buying a USD-listed ETF. Over time, these savings can compound to significantly boost your gains. Let’s see how this works!
Why do we want U.S. ETFs in an RRSP?
Firstly, this article assumes that you have a cheap way of exchanging CAD to USD in your RRSP without paying high currency conversion fees. Some brokers allow you to buy forex at the spot price, while, for others, you can use Norbert’s Gambit. If you aren’t familiar with that, give this article a read.
The main reason we want U.S. ETFs in an RRSP is to avoid the 15% foreign withholding tax on distributions. If you’re a Canadian and own U.S. stocks or bonds, the dividends or income you receive is taxed by Uncle Sam because, well, you’re a foreign investor.
For instance, if you own a U.S. stock with a 5% dividend yield, you will lose 15% of it to tax. This means your 5% dividend yield is reduced effectively to 4.25%. While that may not seem like a lot, it can really add up over time to ding your returns if you reinvest dividends.
There is an exception, though. The IRS recognizes the RRSP as a tax shelter. U.S.-listed ETFs that only hold U.S. stocks or bonds in an RRSP are not subject to the 15% foreign withholding tax. Add this to the lower management expense ratio (MER) of U.S.-listed ETFs, and you can reap significant savings.
Allow me to demonstrate…
Let’s suppose I have two otherwise identical S&P 500 ETFs, both from Vanguard. One is the CAD-listed Vanguard S&P 500 Index ETF (TSX:VFV), and the other is the USD-listed Vanguard S&P 500 Index ETF (NYSE:VOO). Supposed we hold both in an RRSP.
First off is the MER. VFV charges an MER of 0.08% versus VOO at 0.03%. For a $10,000 portfolio, VFV will cost $8 per year, while VOO will cost $3 per year. While both are very low, VOO is the clear winner here, especially as time goes on and as your portfolio gets larger.
We also need to consider the 15% foreign withholding tax on dividends. VOO is unaffected, as it is a USD-listed ETF holding U.S. stocks. However, VFV will be subjected to the tax. This is why VFV’s yield is lower at 1.15% versus VOO at 1.34%. The lower yield reflects the foreign withholding tax being deducted at source.
The Foolish takeaway
To sum it up, Canadian investors should only consider buying USD-listed ETFs if they meet these conditions:
- They have a cheap way of converting CAD to USD;
- The ETF pays a distribution;
- They are investing in a RRSP; and
- They are holding for the long term.
If the U.S.-listed ETF or stock does not pay a dividend, you can buy it in your TFSA without worrying about the foreign withholding tax (as there are no distributions). You can also buy in your taxable account regardless and claim a tax credit, but that can be a hassle for most investors.
