How to diversify my TFSA using ETFs
The Tax Free Savings Account (TFSA) is a gift to all Canadian investors.
I mean, who doesn’t love tax-free money?
Still got a bunch of cash in your TFSA?
That’s fine (I guess) but there are many other great things you can do with your TFSA here.
For years now, we’ve decided to use our TFSAs as a growing income-generation machine – investing in different Canadian banks, telco companies, pipeline companies and real estate investment trusts (REITs).
Holding a number of Canadian dividend paying companies inside your TFSA may or may not appeal to you. In fact, you might want to really diversify your portfolio, specifically your TFSA, using some low-cost Exchange Traded Funds (ETFs) like these fans/readers want to do:
Hi Mark,
I know you can’t offer advice but I’m simply looking for extra information… I want to diversify my TFSA using ETFs. I’m just not comfortable yet using individual stocks. What would be examples of ETFs I could consider and why?
Hey Mark,
I’ve been stuck in paralysis by analysis mode for a few years now with $20,000 sitting inside my TFSA. I know I should get this money working for me since I keep an emergency fund in a savings account. I own various ETFs in my RRSP (I like the benefits that come with these products) but I’ve heard there are tax issues with some ETFs inside my TFSA? Is that true? If so, is there any way I can avoid those tax issues?
Hi,
Wondering if you can help. I need to diversify my TFSA to US equities through ETF holdings. What will be examples or recommended ETFs? From reading your site, I saw you hold VYM which is in USD. Will the dividends and capital gains of this ETF have U.S. withholding taxes if not held in your RRSP? Your help is appreciated.
Wow, great questions from some savvy readers who are passionate about investing!
Well, I will certainly offer what I know folks but I can’t offer direct investing advice. I can share what I’ve learned and thought about for my own portfolio in the past – and that includes the use of ETFs inside my TFSA.
Don’t let the tax tail wag the investing dog for your TFSA
First of foremost, what I’ve learned is, once you have a financial plan in place then picking financial products for that plan becomes a helluva lot easier. Meaning:
- What are you investing goals?
- What are you investing money for?
- What risks do you want to mitigate when it comes to investing?
- How long is your investing timeline?
- And so on and so on and so on….
Personally, if you’re putting products before plans you probably won’t be as successful as you could be.
With that out of way, what I’m implying by the bold font above is tax management should be down your financial to-do list after more important principles of investing are covered. Those principles include keeping your financial costs low for as long as possible and considering diversification across your portfolio. After you’ve factored that in, then being tax-efficient is a good thing too.
Canadian-listed ETFs for the TFSA
Without further delays here are some of the ETF products I like and why, including listing some of the taxation concerns with ETFs inside TFSAs these readers have outlined. My table below is not an exhaustive list of ETFs you can own in each category nor a detailed account about foreign withholding taxes but it does outline my thinking.
| Type of Canadian ETF | TFSA tax impact? | Canadian ETF Examples | General comments |
| Canadian equity | None that I can think of! Canadian-listed ETFs that hold Canadian stocks avoid taxation inside the account. Basically, dividends and capital gains can grow tax-free and money can be taken out of the TFSA tax-free.
| · VCN · VCE · XIU · XIC · ZCN | I personally wouldn’t pay too much more than 0.5% MER for any Canadian ETF, or any fund for that matter. There are many great choices out there but some ETFs have foreign withholding tax implications – money withheld by foreign governments before the dividends are paid to you. |
| U.S. equity (via Canadian ETF) | This is where things can get tricky. While the TFSA continues to provide tax-free growth…there is a wrinkle… Canadian-listed ETFs that hold U.S. equities will have foreign withholding taxes applied, 15% on dividends received. These are withholding taxes you cannot get back; they are not recoverable inside a TFSA as far as I know! | · XUS (holds U.S. IVV) · VFV (holds U.S. VOO) · VUN (holds U.S. VTI) · XUU (a fund of U.S. funds) | Although losing 15% of your dividends is not a huge hit for some U.S. equity exposure, why do that if you don’t have to? Consider this: once your RRSP becomes large enough, use your RRSP-dollar account to hold U.S.-listed ETFs (such as IVV, VOO, VTI, other) or U.S. stocks. You won’t pay ANY foreign withholding taxes if you do that. Quick Example: the withholding taxes on VUN (inside TFSA) vs. VTI (inside RRSP) = 2% yield on VTI * 0.15% charged on VUN = 0.30% extra costs for VUN over VTI beyond the money management fee to run the fund. Something to consider! |
| International equity (via Canadian ETF) | This is where things can get more complicated when it comes to withholding taxes… While the TFSA continues to provide tax-free growth…a double whammy exists for Canadian-listed ETFs that hold U.S. listed ETFs with international equities that pay dividends; this is additional withholding tax. Again, international and U.S. withholding taxes are things you can cannot get back; they are not recoverable inside a TFSA as far as I know! | · XEF · VIU
| Recognizing this additional layer of foreign withholding taxes, I think if you’re going to focus on international equities inside your TFSA it makes sense to buy a Canadian-listed ETF that holds international stocks directly where possible (e.g. XEF, VIU). That said, there are some great ex-Canada ETFs (e.g., XAW or VXC in particular) that regardless of the small hit associated with foreign withholding taxes; the TFSA can be an excellent home for them. See more details below.
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Savvy investors will probably realize two big things in the table above.
1. I didn’t list lots of details about international equities.
While the TFSA continues to provide tax-free growth for assets inside that account, you need to factor in the additional withholding taxes wrinkle depending upon the product you own. A second layer of U.S. withholding tax will apply when the Canadian ETF holds a U.S.-listed ETF of international stocks. An example of that is the iShares product XEC. XEC holds U.S.-listed ETF IEMG. Vanguard’s VDU is another one.
2. I didn’t list any Canadian bond ETFs above.
It’s not because those are not considerations for investors. Rather, given where bond prices are now; the fact that interest rates are low and might rise (a bit??) over time (who knows??), AND to maximize the benefit of the TFSA – tax-free growth and tax-free income, I really, really think you should put growth or income products inside the TFSA.
That’s just me!
What about ex-Canada ETFs or all-world ETFs inside the TFSA?
Ya, why not!
In recent years both iShares and Vanguard have put out some great products to help investors diversify beyond Canada’s borders, including inside the TFSA.
I’m talking about iShares XAW and Vanguard VXC in particular.
I’m a big (and growing) fan of these global ETFs that are ex-Canada because of three key reasons:
- I get global exposure to thousands of stocks I could never afford on my own
- They trade on the TSX so I don’t need to worry about currency conversion (to buy U.S.-listed ETFs)
- They have low management fees.
While the money management fee for XAW is close to VXC, I like XAW. Both products provide excellent all-in-one stock solutions outside of Canada but XAW has more international assets.
If you agree with me that holding Canadian-listed ETFs is the way to go for your TFSA, then I would strongly consider XAW or VXC for ex-Canada exposure.
This way, you can use your RRSP for Canadian or U.S. assets.
While withholding taxes will apply to XAW and VXC inside the TFSA I personally think the additional costs are a small price to pay for the global diversification benefit.
Looking at XAW vs. other Canadian ETFs for withholding taxes inside the TFSA or other accounts:
| ETF | MER – TFSA | MER – RRSP | MER – Non-Reg |
| ZCN | 0.06% | 0.06% | 0.06% |
| XAW | 0.53% (0.22% + 0.31%*) | 0.53% (0.22% + 0.31%*) | 0.26% (0.22% + 0.04%*) |
| ZAG | 0.09% | 0.09% | 0.09% |
You can also check out these posts about some outstanding all-in-one ETFs to own, including all-equity funds where you can own the world of stocks for a puny money management fee!
Don’t want to rebalance? Great! These are simple all-in-one ETFs from Vanguard
Compare VEQT vs. XEQT vs. HRGO equity all-in-one ETFs here!
These are the best all-in-one ETFs to own! No re-balancing required!
This brings me to the following…
What to buy and hold and where?
While it would be more tax-efficient to hold only U.S.-listed ETFs in your RRSP and keep only Canadian content like XIU, VCN and ZCN inside your TFSA it’s not worth obsessing over.
Remember to buy U.S.-listed ETFs you need USD $$.
This means you’ll need to deal with currency conversion costs to convert Canadian money to U.S. dollars to buy those U.S.-listed ETFs; even for your RRSP.
If you want to avoid that mess or just keep things simple, just buy a few low-cost, diversified Canadian-listed ETFs that holds U.S. stocks and/or U.S. and international stocks and spread those funds across your registered accounts (TFSAs, RRSPs, RESPs) first before any taxable investing.
Here are my concluding thoughts:
- Use the TFSA for equities not bonds or cash.
- Use the TFSA for long-term income generation or growth.
- In a TFSA, I think Canadian-listed ETFs (that invest in Canada alone or in foreign equities) are good choices since using a U.S.-listed ETF inside your TFSA does not offer any tax advantage.
- In a TFSA, if you’re going to own some Canadian-listed ETFs consider an all-in-one ex-Canada fund for simplicity OR if you want to focus on international assets then consider owning a fund that holds the international stocks directly since it will help avoid the double-whammy withholding tax exposure.
These are my opinions based on what I know. Your mileage may vary!
Bottom line when it comes to the TFSA
All investors make trade-offs with stocks allocations, bond allocations and cash holdings. There really is no perfect portfolio. Don’t let anyone tell you otherwise.
So my friends, you can definitely go with a few ETFs for your TFSA, or one fund for that account, or replicate a few funds across all your investing accounts, or more combinations.
Instead of being paralyzed by endless analysis, I would encourage you to use this post and other posts on my site as some ammunition to get on with your investing life.
Consider making some low-cost, Canadian equity decisions for your TFSA for growth or income or both and don’t look back.
You’ll be wealthier over time for it.
What are you putting inside your TFSA for wealth-building?
Mark
Mark
My name is Mark Seed - the founder, editor and owner of My Own Advisor. As my own DIY financial advisor, I'm looking to start semi-retirement soon, sooner than most. Find out how, what I did, and what you can learn to tailor your own financial independence path. Join the newsletter read by thousands each day, always FREE.
Mark:
Can one take money out of TFSA if need arises and then deposit the same amount later (say 1 or 2 years later) without penalty?
You bet. Just be careful to keep track yourself since I wouldn’t guarantee CRA being 100% correct, they are always a year behind in reporting, it’s not real-time.
With the TFSA, any money you take out this year, you can get back that same money in contribution room next year + any new TFSA contribution room.
All the best and hope you contribute to the account in 2021!
Hi Mark, I like your breakdown but might add XBB to my RRSP for some global diversification and protection. Any thoughts. Thanks, Nancy
I think XBB is a wise choice for any bond component Nancy. Has a mix of bond durations too.
hi mark
i m a new investor, in my late 30’s
i have a tfsa in discount online brokerage, with following investment :-
CBO.TO
VEQT.TO
VFV.TO
XEF.TO
XIC.TO
HUT.TO
NPI.TO
STOCKS – 45%
ETF – 34%
Cash- 20%
just started out so my investment is below 10K,
1) is my allocation right?
2) do you recommend any etfs more to buy later ?
3) wats your suggestion to have seperate index funds investment like t-eseries ?
4) shoud i move my vfv.to a rrsp ?
appreciate your advise . thanks
Thanks for being a fan of the site Thomas!
I can’t offer direct advice, for many reasons, but I can say…
1) is my allocation right? I think depends on your goals (aggressive investment risk?? about 80% stocks is suited for long-term growth but you’ll need to ride market volatility short-term.)
2) do you recommend any etfs more to buy later ? (I have my favourites here!)
https://www.myownadvisor.ca/etfs/
3) wats your suggestion to have seperate index funds investment like t-eseries ? (I think TD e-series are great and they are simple, effective solutions for many investors!)
4) shoud i move my vfv.to a rrsp ? (I’m personally a fan of U.S. listed ETFs in my RRSP but I think if you don’t want USD <> CDN $$ currency conversion headaches it’s smart to low-cost CDN listed ETFs like VYV in any registered account. Well done).
https://www.myownadvisor.ca/what-are-the-best-etfs-for-my-rrsp/
Happy investing!
Mark
All those comments about equivalence of TFSAs and RRSPs for USA withholding taxes are incorrect. Since a TFSA is not recognized by the USA as a retirement account, there is full withholding with no allowance for tax recovery. This is true whether or not the ETF is Canadian domiciled (the Vanguard AA ETFs), or one buys a USA-domiciled ETF, where the tax treaty allows for zero withholdings on distributions in a RRSP or RRIF account only. The authoritative tax info is to be found on Justin Bender’s Canadian Portfolio Manager blog and website.
Any info on tax-friendliness for TFSAs that is found here is incorrect, and a lot of comments suffer for this misinformation.
Hi David,
We agree, since the TFSA and RRSP are treated differently for withholding taxes. Since Justin has done extensive work on this, I have actually linked to his whitepaper on my Dividends page.
Thanks for your comment.
Appreciate your thoughts but the multiplicity of ex-Canada recommendations and comments for use in a TFSA deserve a major caution in defining the difference between RRSPs and TFSAs for tax purposes. Whether the tax impact is said to be minor, the awareness of the treatment is significant, what with all the ex-Canada mentions.
In brief, any Canadian domiciled ETF has maximum withholding taxes extracted and are not recoverable. Usage in these accounts ought to be treated as a negative. In a taxable account ETFs which are not merely funds-of-funds of US or International ETFs, but hold individual equities, provide credits eligible for foreign tax recovery.
In a RRSP or RRIF, the tax treaty provides for zero withholding on US domiciled ETFs, and for International ones that hold individual equities, one level of tax relief.
This makes non-Canadian assets in a TFSA less desirable. We learned our lesson after buying US-domiciled ETFs in TFSA, to no relief, but for portfolio commonality then switched to 100% VGRO there. Have recently dialed down the equity by swapping them for VCNS. So I do have foreign content in TFSA, and agree tax treatment ought not to wag the dog.
To others, I’d add, to do this in a TFSA with any foreign ETFs — be aware. And to do this in a RRSP, use only US-domiciled ETFs and escape much tax hit.
Your link to Justin Bender is noted and its his authoritative efforts that we both celebrate and benefit from.
Thanks David.
I mean, I’m no expert on this stuff and never claim to be, but for the reasons I’ve learned 10+ years ago:
1. I keep only U.S. listed ETFs in my RRSP (eventually RRIF) and my LIRA to avoid any withholding taxes. I own VYM. I don’t own any CDN ETFs in my RRSP and don’t intend to since I’m striving for tax optimization.
2. I tend to keep CDN REITs in my TFSA because I’m lazy and can’t be bothered with ACB and any other ROC calculations.
3. I tend to keep CDN dividend paying stocks in my non-reg. account for the CDN dividend tax credit, I also keep a few low-dividend payers there to keep taxation to a minimum. As I get older, I might keep U.S. dividend paying stocks (low yielders) in my taxable account and recover those withholding taxes.
“Whether the tax impact is said to be minor, the awareness of the treatment is significant, what with all the ex-Canada mentions.”
Fair point!
Based on your lesson learned, you are smart to go with VCN or VCE or an equivalent all CDN-content fund. That said, I think investors who want to keep it simple can definitely use a VGRO or VEQT in their TFSA and sleep easy.
Kudos to your knowledge.
Mark
Thanks for the article. Although I’m still a little confused. Would something like VBAL be subject to withholding tax? VBAL is composed of seven different Canadian and international Vanguard ETF’s. I ask because they are stocks held in an ETF, which is held in another ETF.
At what point is the tax paid, or is it paid twice?
Thanks for your question Patrick.
The short answer to the first question is, yes.
When it comes to all-in-one funds, consider that the more bonds in the fund, the more the tax drag for any of these funds will be in a taxable account. When it comes to TFSAs and RRSPs, you don’t need to worry about that.
Now, in terms of withholding taxes on equities, it is complex. For example, because the funds hold VIU – VIU will only be subject to one level of unrecoverable foreign withholding taxes in tax-free and registered accounts.
On the flipside then, inside TFSAs and RRSPs, the more conservative the Vanguard all-in-one fund (i.e., the higher the bond component) the LESS withholding taxes you’ll pay.
Reference:
https://cdn.canadianportfoliomanagerblog.com/wp-content/uploads/2018/02/Vanguard-Asset-Allocation-ETFs.pdf
Withholding tax is complex in that since you have U.S. and international layers.
I hope that helps a bit!
Brilliant. Thanks for the distinction between a taxable account and the TFSA. The link was just what I needed to round out my understanding of the withholding tax.
Justin’s site is excellent and he goes into great detail about withholding taxes for assets inside various accounts (e.g., TFSAs, RRSPs, taxable).
Again, as a low-cost ETF investor, I’ve learned from others that it’s probably one of the last things you really need to consider after getting your asset allocation right, savings plan right, long-term financial plan organized (including debt management). Withholding taxes can make a difference over time but it’s usually a bigger impact to a large portfolio value.
All the best,
Mark
Thanks Mark!
One last question, what do you mean by there is no problem with holding XUS with as little as a few thousand bucks?
Would the money be better off buying larger amounts in Dividend paying stocks for example?
I figured putting the bulk of my money into XUS would be a good way to start and have a large share of the market as my initial nest egg.
Hey Talon,
What I mean is, you don’t need to save tens of thousands of dollars in cash to start low-cost investing.
Most experts advise people to get an emergency fund in place, then, after that is funded, start investing for long-term growth. I would have to agree!
Excellent article as always, Mark. I’ve been reading and studying this website for a couple weeks now, reading everything I can. I really like the growth and dividend approach.
I am new to investing and have been interested in XUS, XAW and VGRO / XGRO
To my understanding
VGRO / XGRO should be held in TFSA
XUS should be held in TFSA as long as my portfolio is under 50,000.
And XAW can be held wherever because the global exposure is worth the withdrawal tax.
I’m 29 and currently have 40,000 to invest, the wife has 15,000.
I really wanted to buy roughly 20,000 into XUS, but I wouldn’t be able to put all that into an RRSP as I believe the amount you can put into an RRSP is 18% of your income from last year, which would leave me at a little over 10,000 contribution room. Should I just put 20,000 into the TFSA since my portfolio isn’t large enough to worry about the withholding tax just yet? Also I’m assuming these Canadian ETF’s that hold some American stocks like XUS can be bought in Canadian Currency?
– Thank you for your time.
Awesome Talon. Happy to have you as a reader!
Personally,
1. VGRO / XGRO should be held in TFSA – no problem with that at all. Save your $6k or so per year, invest inside your TFSA, rinse and repeat for 25+ years and wake up wealthy.
2. Most the bloggers and investors I know – hold XUS inside their RRSP but TFSA is good too.
If you have a long-term time horizon, there is no problem with holding XUS with as little as a few thousand bucks. There really is no threshold that you must pass to buy ETFs.
3. XAW will be charged withholding taxes.
Have a read of this page because even Canadian-listed ETFs (that hold U.S. assets or international assets) are charged withholding taxes.
https://www.myownadvisor.ca/indexing/
re: RRSP contribution limit for 2019 = 18% of earned income you reported on your tax return in the previous year, up to a maximum of $26,500. (For 2018, the upper limit was $26,230.)
Again, personally, I always try and max out my TFSA first – and I do.
https://www.myownadvisor.ca/ill-continue-to-maximize-my-tfsa-first-because/
After my TFSA is maxed every year, I make monthly RRSP contributions to max out that account. And I will in 2019.
Back to you….re: withholding taxes – don’t sweat them. By investing in any of those funds above you’re already SO FAR AHEAD of the game.
To put withholding taxes into context, I think it only matters once your portfolio is approaching $100,000 invested inside an account (e.g., RRSP).
The difference between holding VOO (US fund) and VFV (CDN equivalent) on $100,000 CDN invested in RRSP is:
~ VOO ETF yields (1.5% – 0.03% VOO MER) x 0.15% withholding = 0.22 in lost fees if using VFV.
So, VFV MER = 0.08% MER + 0.20 in lost fees = estimated cost of holding VFV in RRSP = ~ 0.30%.
Compare that with VOO in RRSP alone at 0.03% with no withholding taxes.
What does that 0.27% difference mean on an $100,000 RRSP portfolio? $270 per year.
Once your portfolio or RRSP or TFSA is greater than $100,000 invested, I think it makes sense to start thinking about tax efficiency since $270 per year over many years might add up 🙂
Cheers,
Mark
While globally neutral 2 fund solutions like VCN/VXC or VCN/XAW are outstanding choices, we’ve chosen to embrace the new Vanguard asset allocation 80%-equity VGRO because it’s automatically rebalanced for you, and includes emerging markets. The bond component is attractive because it includes US and International bonds, despite the principle that TFSA is the place for equities. We’ve had multiple ETFs in our TFSA over the accounts’ lifetime, but this is our approach, as retired couch potato index investors.
Mark, I ageee with your conclusions. People to tend be concerned too much about foreign withholding taxes in the TFSA, which should be reserved for equities because of higher expected return of equities. Expected return far outweighs any concern about foreign withholding taxes in a TFSA, and as we cannot know which part of the world will have the best return going forward, it makes sense to put some of each – eg. 1/3 each of Canada, US, international markets.
I absolutely think the TFSA should be full of equities…but that’s just me. People fuss over withholding taxes but the reality is, that’s WAY down on the list of priorities for most investors. Thanks for your comment as always.
The MER is high at 1.04%, but over the last 10 years, even AFTER factoring in that MER, it has still outperformed most most ETF’s that are comparable – 10 yr average return = 10.4%. I have been happy with it, so I kept it – and put the rest of my mutual funds into ETF’s.
Yes, true, mutual funds report performance after MERs are taking into account. That is a solid fund Jordan. Some mutual funds are good products!
Great post (as usual) Mark.
I hold XAW in my RRSP, as well as a Canadian equity fund and use my TFSA (like you) to hold Canadian stocks.
A nice breakdown of some of the best ETF’s as well. I know you are a huge fan of ETF’s (and I am too) but I still hold RBC Canadian Equity Income Mutual fund CLASS D (lower MER), and although the MER is higher than a lot of the ETF’s, it has outperformed almost all similar ETF’s with lower fees I could find.
XAW is a great product for the RRSP, as is VXC. Smart man.
Nothing wrong with mutual funds as long as they are lower-cost and for the fee, you’re getting the value for service 😉
I owned the RBC income fund a decade ago. It’s expensive with a MER of 1.04% with an objective stated as “To provide a high level of monthly cash flow and
relatively tax efficient distributions consisting primarily
of returns of capital, capital gains and interest income
and to provide the potential for modest capital growth”.
Great points, especially about not using your TFSA for speculative investments. TFSAs are so flexible that you don’t want to destroy contribution room by having a speculative investment inside your TFSA go bust (plus speculative investing is just a bad strategy for the average investor anyway).
We’re trying to max out our TFSA each year with the goal of having $1M in our TFSAs by age 55.
“We’re trying to max out our TFSA each year with the goal of having $1M in our TFSAs by age 55” – that would be HUGE Owen.
I hope you get there 🙂
that’s impressive to hit $1M by age 55. That’s like a annual growth rate of 15-20% in there in order to hit that.
Yes, I believe anyone that can amass $1 M portfolio by age 55 must be a good saver. There are certainly folks saving far more money than I am though!
Hi Peter! I should clarify that $1M is in our combined TFSAs, so both mine and my wife’s. We’re targeting $500k in each TFSA and $1M in total. Still a stretch, but with an individual target of $500k it’s a much more reasonable growth rate that anyone can achieve over a long enough time frame.
That would be HUGE for you Owen – $500K in each TFSA. Dream big! Mark