Monday, January 25, 2010

RRSP vs. TFSA: Foreign Dividend Taxes

Many experts have commented on the relative merits of RRSPs and TFSAs for Canadian investors. Once people realize that TFSAs aren’t just for cash or GICs, they realize that they have to choose between RRSPs and TFSAs for their long-term retirement savings in all its forms: stocks, bonds, real estate, etc.

The main consideration in this choice is tax rates. If your marginal tax rate while working is higher than it will be when you retire, then RRSPs look good. Some lower income Canadians will see their effective marginal tax rates increase because of the claw-back of the GIS and other government programs.

Another lesser, but still significant consideration is taxes on foreign dividends. The U.S. in particular has a tax treaty with Canada so that dividends from U.S. companies have no tax withheld when Canadians hold the stock in RRSPs. When U.S. stock is held in a regular taxable account, the standard withholding tax on dividends is 15%. Unfortunately, this 15% withholding tax applies to TFSA assets as well.

Let’s take the example of a 30-year old investor, Neil, who wants to invest a slice of his retirement savings in a U.S. stock index ETF. Let’s suppose that this investment will be held until Neil is about half-way into retirement, say about 45 years, and that all dividends will be reinvested.

If the dividend yield over those 45 years is 3%, then holding the ETF units in his TFSA will only give Neil a 2.55% yield (15% less). His RRSP would get the entire 3%. For one year, the difference is small, but over 45 years, the TFSA would have 18% fewer ETF units than the RRSP would have.

So, when the time horizon is long, foreign dividend tax considerations are important for choosing between RRSPs and TFSAs.


  1. Wow, what a weird little wrinkle. Do you suppose this was intentional?

  2. Patrick: My guess is that the US doesn't recognize TFSAs are a retirement savings vehicle. So, it doesn't fall under the tax treaty.

  3. The US doesn't recognize TFSAs as a "pension trust"...which creates another wrinkle for US citizens that are Canadian residents:

  4. Great post!

    Hey Michael (and others) - do you know if the Canada-U.S. tax treaty makes a RSP Locked-In Retirement Account (LIRA) exempt from U.S. withholding taxes?

    I would like to hold U.S. dividend-paying stocks in my RSP LIRA (like Johnson & Johnson), but I do not want to be penalized for this by paying any withholding tax.

    I have a LIRA because I had a pension with my former employer.

  5. @Financial Cents: My understanding is that the treaty does cover LIRAs, but after checking my records, I realized that I've never had a US dividend-paying stock in my LIRA. You'll need to confirm with someone else.