I generally shy away from making tactical asset allocation decisions. That is, I’m not trying to predict the economy for the year ahead and alter my investment mix to “optimize” it. Frankly, I think it’s foolish and a waste of time.
What I do focus on, however, is tax efficiency. Once you’ve maxed out your registered accounts like your Registered Retirement Savings Plan (RRSP) and Tax-Free Savings Account (TFSA), making your portfolio more tax-efficient becomes crucial, especially as you earn more.
Here are two tricks and tips to help you keep more of your hard-earned money out of the Canada Revenue Agency’s (CRA) hands.
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REITs in a registered account
If you’re looking for exposure to Canada’s real estate market, the BMO Equal Weight REITs Index ETF (TSX:ZRE) is an excellent choice.
It offers a decent 5.3% yield with monthly income while spreading risk across Canada’s real estate investment trust (REIT) sector. The catch? It’s not very tax-efficient.
Unlike Canadian stocks, REIT distributions don’t qualify as eligible dividends. Instead, they’re classified as a mix of largely ordinary income and some return of capital (ROC).
Here’s the issue: ordinary income is taxed at a higher rate compared to eligible dividends. Eligible dividends benefit from a dividend tax credit, which lowers the amount of tax you owe.
REIT distributions, on the other hand, are treated like employment income, meaning you could lose a larger portion to the CRA if held in a taxable account, especially if you already make a lot.
If you want to reinvest your REIT or REIT ETF distributions fully without worrying about the tax bite, it’s best to keep them in a registered account like your RRSP or TFSA.
Corporate class ETFs in a non-registered account
In a non-registered account, every distribution you receive – whether it’s eligible dividends, non-eligible dividends, capital gains, ordinary income, or return of capital – needs to be reported and taxed accordingly.
Keeping track of these, along with your adjusted cost basis, can be a hassle. Filing T5 slips every tax season? Even more so.
If you want to simplify your tax life, consider investing in a corporate class ETF. A great example is the Global X S&P 500 Index Corporate Class ETF (TSX:HXS).
This ETF provides the total return of the S&P 500 Index, net of fees and expenses, but without paying any distributions. How does it manage this?
Instead of directly holding stocks, it uses swaps to replicate the index’s total return (including reinvested dividends). This is called a synthetic strategy. The result?
In a non-registered account, you won’t pay any tax until you sell the ETF and realize a capital gain. This means you can defer taxes, potentially for years, allowing your investment to grow more efficiently –unless, of course, the government decides to change the tax rules down the road.
