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As a father of school-aged children, the term “registered” tends to trigger an involuntary and unpleasant physical response. Have we successfully registered for swim lessons? (Answer: You’re kidding, right?) Have the kids registered our 15th plea to put their shoes on and get out the door? (Answer: See above.)
So let’s turn our attention this week to the world of non-registered investment accounts – taxable but, for me at least, less emotionally taxing.
What are the tax implications of holding ETFs such as XEQT in a non-registered account, and what information do I need at tax time? I understand income includes distributions, not just dividends.
If you have already used up your TFSA and RRSP contribution room, you could do a lot worse than putting your money into a broad equity ETF such as the iShares Core Equity ETF Portfolio (XEQT).
If you hold an income-generating ETF in a registered account, you don’t need to worry about reporting that income at tax time. In a non-registered account, you’ll have to do some tax homework, but it’s worth the effort – particularly in preparation for when it comes time to sell.
I’m 67 and retiring, but my spouse will keep working. Should I wait until 70 to take CPP?
Let’s address the income side first. You can find ETF distribution data on CDS.ca, home of the Canadian Tax Breakdown Reporting Service. For XEQT, income may include a mixture of eligible dividends, capital gains and foreign income. You will also see return of capital (ROC) and non‑cash distributions.
XEQT’s non‑cash distributions are reinvested capital gains distributions, which appear on your T3 slip under capital gains. Your T3 should contain all the information you need for annual filing, and in your non-registered accounts, you may be able to recover some foreign withholding taxes through foreign tax credits. So far, so good.
It’s the non-cash distributions and return of capital that introduce a wrinkle. The former will raise the adjusted cost base of your shares and the latter will lower it, both affecting capital gains on future sales. Fortunately, ROC is summarized on your T3. For details on reinvested capital gains, turn to CDS.ca.
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If you want to keep things simple, and if your ETFs are purchased and held within a single non-registered account, you can leave it to your brokerage to track your adjusted cost base (ACB).
This will probably work, but it still pays to keep your own records in the event of a brokerage error. Questrade’s website warns that the “Cost or Book Value” on T5008 slips is “frequently unreliable” because it can exclude adjustments like ROC.
A reader shared a harrowing experience of his brokerage reporting around $150,000 in capital gains to the CRA as more than $8-million. Fortunately, he had done his ACB homework.
If you hold the same ETF across different brokerage accounts, it’s even more important to track your ACB, as your brokerages will not be able to do this for you. You can do it yourself in a spreadsheet, but I like adjustedcostbase.ca, which is designed to make the process as painless as possible.
As a retiree, is it a bad idea for me to hold dividend stocks in a non-registered account? I’m afraid the ‘gross-up’ of dividends could create ‘phantom’ income that could increase the OAS clawback.
It’s not necessarily a bad idea.
A bit of background for non-retirees first. Monthly Old Age Security payments for Canadians over 65 are reduced by 15 cents for every dollar of net income over a certain threshold (currently $95,323) through the pension recovery tax, or “clawback.”
Taxes on eligible dividends in non-registered accounts are based on a “grossed-up” figure that is 38 per cent higher than the dividends paid, intended to approximate a company’s pre-tax income. While you can claim tax credits to partly offset this, some seniors worry about “phantom” income, as the OAS clawback is calculated using the higher income figure, which they don’t actually receive.
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This may appear unfair as you wouldn’t see interest or pension income subjected to a gross-up. In practice, it’s less of a burden.
“When combined with the dividend tax credit and more favourable tax treatment, an individual usually receives more after-tax income by opting for dividends, even after accounting for the OAS clawback,” said Josephreen Luk, CPA, founder of Bloom Accounting in Vancouver.
This is general guidance assuming similar dividend and interest income. “Other factors such as the individual’s marginal tax rate, total income level and specific ROI may alter the outcome,” she said.
Holding dividend stocks in a non-registered account is “not necessarily a mistake,” but retirees should be aware of the clawback risk, said Ms. Luk.
In short, hold dividend-paying investments in your TFSA when possible because dividends received there aren’t taxable and don’t count toward net income. But don’t rule out dividend stocks in non-registered accounts if the math works for you.
E-mail your questions to agalbraith@globeandmail.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.
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Editor’s note: This story has been updated to correct the threshold for the OAS clawback. It is $95,323, not $90,997.