Tax Preparation 2018

As 2018 winds up, it is time to think about investment taxes and other financial housekeeping once again.

For the purposes of this post, make sure you complete any transactions no later than December 27, 2018 for them to settle in the 2018 tax year. If you execute the trade after this date, the tax gains or losses will apply in 2019.

Also, many of the investment taxation issues apply only to non-registered accounts. If your money is solely in a TFSA or RRSP, you don't need to worry about investment taxes.

However, if you are withdrawing from a TFSA or RRSP this year you will want to pay attention.

Re-balancing Portfolios

Given the market gyrations of 2018, you are likely to give some great opportunities for re-balancing and taking some tax losses.

Remember, in Canada capital losses can be carried forward indefinitely to offset future capital gains. They can also be used to offset capital gains already paid in the 2015, 2016, or 2017 tax years.

Leveraged Barbell Portfolios

If you are tracking one of the leveraged barbell portfolios which I share on this blog, you are likely to be down on a capital basis on your leveraged equity ETF (UPRO, SPXL, or HSU.TO) for this year.

If that's the case and you are investing in a non-registered account, it could be advantageous to book the loss now. To avoid superficial loss rules, you could buy a small cap leveraged ETF instead (URTY or TNA, for example). You could also buy the emerging markets leveraged ETF, which has dropped significantly this year (EDC).

Given the rise of interest rates this year, you are probably down on your bond holding as well. Again, if you are investing in a non-registered account consider booking the loss and buying a similar, but different bond ETF instead. For example, you could sell BSV and buy VGIT.

Make sure you re-balance correctly to your target allocation. Unless it is in your plan and you've carefully thought it through, do not increase your risk.

Couch Potato Portfolios

This year was an interesting year for Couch Potatoes as well. If you follow the standard CCP model ETF portfolio, you are holding XAW.TO, VCN.TO, and ZAG.TO as recommended by Dan Bortolotti.

Every one of these holdings are down for the year. Depending on when you started following CCP, you could have a capital loss on all of your holdings.

To book the losses and avoid the superficial loss rule in non-registered accounts, you could:

  1. Sell XAW.TO (which tracks MSCI Indices) and replace with VXC.TO (which tracks similar FTSE Indices);
  2. Sell VCN.TO (which tracks the FTSE Canada Index) and replace with XIC.TO (which tracks the S&P/TSX Capped Composite Index); and
  3. Sell ZAG.TO (which tracks the FTSE TMX Canada bond index) and replace with VAB.TO (which tracks the Bloomberg Barclays Canada bond index)

Regardless of taxes, the end of the year is always a great time to re-balance your portfolio back to your target allocation. Canadian stocks in particular have dropped quite a bit this year and should be topped up if you're following this strategy.

Tax Loss Harvesting

If you are investing in a non-registered account, now is the time to re-evaluate all your holdings and determine if you really want to keep them.

Many securities have declined quite drastically this year and, if they no longer fit in your portfolio, it is time to book the capital loss and use it to offset prior year, current year, or future capital gains.

If you like the current exposures you have, but you still are holding positions with a sizeable loss, you should consider selling anyways, booking the capital loss, and replacing the holding with a similar but different asset.

This could mean selling one energy asset for another, replacing gold (GLD) with silver (SLV), replacing BMO Bank (BMO.TO) with CIBC (CM.TO), and so on. Almost every asset on the market has very tight correlations with another asset.

Tax Gain Harvesting

In a prior post, I have gone into depth about the benefits of strategically harvesting capital gains in non-registered accounts when you are in a low tax bracket.

Unlike capital losses which are subject to the superficial loss rule in Canada, you can legally sell an asset, or part of an asset holding, for a gain and then repurchase the same asset immediately.

Doing this carefully at low capital gains tax rates can steadily increase your adjusted cost base and significantly reduce future tax liabilities.

This strategy is best done when you are not earning other income, such as employment income or RRSP withdrawals.

Ideally you want to realize capital gains when you are in the lowest tax bracket and you can offset the realized income with interest expense or other tax deductions.

Spousal Loans

Although the CRA prescribed rate has crept up this year, you can still make a spousal loan for just 2 percent annual interest.

Spousal loans can be a very tax friendly strategy for moving assets from a high income, high wealth spouse to a lower income spouse. Here are the steps to do this:

  1. The high income spouse writes a legal contract with the low income spouse for a loan meeting the conditions required by the CRA;
  2. They transfer the loaned money to the low income spouse;
  3. The receiving spouse invests all of the money in a non-registered account, buying income generating assets like stocks which pay dividends;
  4. The receiving spouse pays their partner the necessary interest payment at the end of each year, but can deduct that expense from their income at tax time as it is an investment loan;
  5. The high income spouse must claim the interest income and pay taxes on it.

In this strategy, the high income spouse moves their wealth to the low income spouse via a legal contract. They get some taxable interest income, but at a 2 percent rate it is very minimal.

The lower income spouse gets almost all the wealth growth and pays much less tax on this wealth growth than the higher income spouse would if they had invested the money themselves.

In most cases this strategy should only be considered for individuals who have already filled their registered accounts, have a meaningful amount of excess money to loan to their spouse, and their spouse earns significantly less income.

TFSA Contributions or Changes

A few weeks ago, the government has announced they will be increasing the TFSA contribution amount to $6,000 for the 2019 year.

This means a couple will be able to invest $12,000 in their TFSAs and grow that money forever, but pay no taxes on the wealth growth.

If you're really rich, you can also put money into an adult child's TFSA, provided they earned some money and file a tax return.

Try to fill your TFSAs as soon as you can. You might need to transfer money from your non-registered account but, if you do this is January, you won't pay taxes on any realized gains for nearly sixteen months. Of course if you have capital losses you can realize, take them in 2018.

Moving Your TFSA

If you've been thinking about moving your TFSA to a new brokerage, now is the time to plan this carefully to avoid pesky over-contribution rules and penalties.

  1. Complete the paperwork to open a new TFSA account at your desired broker. I like Questrade and National Bank Direct for registered accounts—they each have their own advantages for different situations;
  2. Withdraw all the money from your existing TFSA account before the end of December, close the account, and hold the cash in your personal chequing account; and
  3. Deposit the money into your new TFSA account in the beginning of January.

You should be able to move TFSAs without incurring any fees aside from some trading commissions if they apply.

Always check first, but most good banks do not charge fees to close TFSA accounts. If they do, you could just keep them dormant forever with a few pennies in the account.

RRSP Housekeeping

Get ready for so-called "RRSP Season" which runs from January through the end of February. During this time you can make RRSP contributions and apply them against your 2018 income—saving you money on income taxes.

Unless you expect a significant pay raise in 2019, try use your RRSP room as soon as possible. This is especially true if you earn over $93,208 in 2018. There's no point in running a big tax credit with the government—they charge interest, but they don't pay it.

If you are retired, were a stay-at-home mom, took a sabbatical, or experienced a temporary loss of income, consider making RRSP withdrawals to take advantage of low tax rates.

As I often state on this blog, I am a big proponent of what I call "tax-targeting". Try realize as much income as possible at a reasonable tax rate given your personal situation.

If you can realize income at an overall tax rate of 10 percent, take advantage of the opportunity! You can use the withdrawn money to fill your TFSAs, non-registered accounts, or even pay off debts.

Smith Manoeuvre

If you've implemented the Smith Manoeuvre, the coming weeks are a great time to get your paperwork in order, make sure the strategy is running smoothly, and make any necessary tax adjustments for RoC distributions.

Given the amount of paperwork and running around involved in establishing a proper Smith Manoeuvre process, this time of year could be a good time to get things arranged for a new Smith Manoeuvre.

Although you should anticipate pretty meagre future returns in many equity markets for some time, the Smith Manoeuvre is a long term process.

Also, the biggest benefit of the Smith Manoeuvre is the tax savings—which are substantial over time! These tax savings can help you save more and invest more, growing your overall wealth.

Interest rates are still very low by historical standards and can drop significantly if we enter another recession. With the U.S. Federal Reserve indicating they are coming to the end of rate increases, I think HELOC rates in Canada are also unlikely to increase much more.

Blog Stuff

The blog continues to grow, albeit more slowly than before. I have shifted a lot of my posts over to a more technical and advanced perspective designed for more experienced investors.

I understand this might fly over the head of the typical Canadian who continues to pickle themselves in debt, live paycheque to paycheque, and pray for ever higher house prices (if they own a house).

I'm making this shift intentionally as there are countless blogs out there which preach personal finance basics, push Couch Potatoesque investing, and try sell you credit cards or other financial products. My target audience is the more advanced investor who hopefully has the basics taken care of.

During 2018, readers have come to the site more than 16,000 times. You have read more than 35,000 pages and left over 300 comments.

Thank you and I hope you will continue to be engaged, ask questions, and give me things to think about.

I truly believe my own investing process is getting better because of the things I explore; much of it inspired by comments and emails I receive from readers.

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Why Bonds Should Go in Your Non-registered Account

The conventional wisdom in much of the Canadian financial blogosphere is tilted to holding bonds in your RRSP. However, the logic behind this generalized advice is not as optimized as it should be for an investor who wants to maximize their after-tax wealth.

We know RRSP withdrawals are subject to full rate taxation. By standard financial planning, big RRSPs are a big problem, especially once you hit the age of 71 and mandatory withdrawals kick in (via RRIFs).

Large withdrawals can put you into high tax brackets, sometimes even higher than your working years. In the worst case scenario, they can reduce your seniors benefits such as OAS.

Bottom line, a high embedded tax liability can significantly reduce the real value of your RRSP, and thereby your true wealth.

Unlike RRSPs, TFSA growth is never taxed again, including withdrawals. There should be nothing holding back the investment growth in your TFSA account.

Bonds have historically provided lower returns than stocks. This has led some of the financial industry to promote placement of low growth assets—like bonds—in RRSPs. However, this only makes sense if you exclusively invest in a TFSA and RRSP.

Bond interest is taxed at full rates on top of your other income. For tax efficiency and investment return reasons, you generally want to avoid having lots of interest income in your non-registered investment account.

While I believe you should seek to limit inflexible taxable income at all times, it is especially when you are working and your interest income can be taxed at marginal rates of 40 percent or higher.

Since many of the most popular bond ETFs generate the vast majority of their returns via distributed interest income, high taxes on this interest can substantially reduce your true bond returns.

Bond Return Realities

If you take a closer look, bond returns are actually much more dynamic than the simple interest income, especially in managed or index bond ETFs.

Bonds not only generate interest income, they also return capital gains (which are taxed at a 50 percent inclusion rate) and return of capital (which is not taxed per se, but lowers your cost base).

This means bond ETF distributions and overall bond ETF returns can be much more tax efficient than you think.

Thanks to financial innovations, bond ETF structures have evolved to become increasingly tax efficient. Every self-directed investor today has access to low cost bond funds which have these tax efficient features.

In Canada we have swap-based bond ETFs which are super efficient, essentially converting all returns to deferred capital gains.

We also have a discount bond ETF which invests in bonds discounted from their face value. This reduces interest income and increases capital gains (both distributed and deferred).

Further down, we will look at bond returns for several popular ETFs including XBB.TO (a standard bond index ETF), ZDB.TO (a discount bond ETF), and HBB.TO (a swap-based bond ETF).

RRSP Structure vs Non-registered Account Structure

To understand the effects of taxes on this bond allocation question, it is important to review the tax implications of RRSPs compared to non-registered accounts.


RRSPs are first and foremost a tax deferral account. While you make RRSP contributions with "before-tax" money (you claim the contribution amount on your income tax return to reduce your taxable income), you pay full income taxes on RRSP withdrawals.

Apples for apples, after the tax break at your highest marginal tax rates, you can contribute more to your RRSP than any other self-directed account.


If you are in the 40 percent tax bracket and you have $10,000 cash to contribute to an account, you will actually be able to gross up your RRSP contribution to $16,666 after factoring in the $6,666 you will get back on your tax return the following spring. If you don't have the extra $6,666 to contribute, you can borrow it from your bank via a short-term loan and pay them back once you get your tax refund.

Moose Tip!  Plan ahead and complete a T1213 form with the CRA to reduce the taxes withheld from your paycheque.

A second large advantage to RRSPs is you pay no taxes on any investment income or gains held within your RRSP account. You only get taxed when you actually withdraw money from your RRSP.

You can buy and sell securities, realize profits, collect dividends and interest income and pay no tax. RRSPs can be a good place to engage in active, higher return investment strategies as there is no tax drag on your returns.

Finally, RRSPs are recognized as a retirement account with many of Canada's tax treaty partners. The tax treaty arrangements mean that any distribution income from U.S. listed ETFs or stocks will not be subject to U.S. withholding taxes (saving you 30 percent tax on the distribution amount).

Non-registered Investment Accounts

A non-registered investment account has far fewer benefits which translates to lower contributions and lower returns.

You cannot deduct contributions to these accounts from your income at tax time. Depending on your tax bracket, this effectively reduces your true contribution amount by 30 percent to 50 percent compared to your RRSP.

Also, you must pay taxes on any realized income each year. This includes dividends, realized capital gains, return of capital, and interest income. Certain forms of income such as capital gains and Canadian dividends are taxed at lower rates, while capital losses can be used to offset gains.

The tax costs of constantly having to claim this income each year is called the tax drag. In an efficiently invested account, the tax drag will often be 0.5 percent of your account value. In a poorly managed account it can be much higher.


In the same 40 percent tax bracket you can only contribute the $10,000 you have in your hands. This means right off the bat, your non-registered account balance is more than one-third smaller than your RRSP would be. If you realize dividend income during the year, it will be taxed at approximately 25 percent, reducing your investment returns. If you realize some capital gains (profits) on the sale of an asset in any year, you must include half of the profit to be taxed. This would translate to an effective tax rate of around 20 percent on the profit portion at this income level.

Broad Bond ETF Comparisons

Here are the actual bond returns for three popular bond ETFs with very different tax structures. We used the 2014 to 2018 time period as many bond ETFs are still quite new to the Canadian market.

The indices these ETFs follow are also somewhat different, so part of the difference in the returns is due to the particular index being tracked. For example, XBB.TO holds 35 percent federal government bonds while HBB.TO holds 42 percent federal bonds.


Taking a quick look at this chart, you can see that the simplest bond ETF (XBB.TO) has the largest overall pre-tax gain. This is not surprising since ETFs which engage in more transactions or have more complex structures naturally will have somewhat higher fees and management costs.

It should be noted that the management fees have compressed in ZDB.TO and HBB.TO. The return differential between these ETFs and a standard bond ETF is likely to shrink further in the future. Going forward the return difference between XBB.TO and HBB.TO is likely to be under 15 basis points.

We know that, if you only have a RRSP and TFSA account, the RRSP is the better of these two options in which to hold your bond allocation.

Moose Tip!  If you hold bonds in your RRSP, choose the cheapest, simplest bond ETFs (XBB.TO, VAB.TO, ZAG.TO, etc.). The interest income will not be taxed.

Tax Comparisons for Non-registered Accounts

Lets take a look at tax liability for these funds should you hold them in a non-registered account, assuming the investor is in the 40 percent tax bracket.

To keep the numbers simple, we'll assume that the bond holding started at $100,000 in May 2014 and you are selling your holding in June 2018.


Despite the higher pre-tax return of the simple bond funds, the tax advantaged bond ETFs are a much better choice once taxes are factored in.

The swap-based bond ETF (HBB.TO) outperformed the simple bond index ETF by 25 percent over four years purely due to the compounding effects of tax drag on realized income.

Bonds are for Non-registered Accounts

Given the benefits of tax efficient bond ETFs, it is suddenly very feasible to hold your bonds in your non-registered accounts. After adjusting for tax drag, return metrics, and some other factors, bonds should be held in your non-registered account for maximum post-tax wealth gain.

Since most Canadians will only ever invest in TFSAs and RRSPs, the average Canadian investor with a conventional buy-and-hold portfolio will have their bonds in their RRSP. Of these two registered accounts, it is definitely preferable to put bonds in the RRSP over the TFSA. TFSAs are for unbridled growth assets, not slow growing bonds.

But many Canadians who are aggressively building wealth, myself included, invest a substantial portion of their assets in a non-registered account. Once the TFSA and RRSP accounts are full, non-registered investment accounts are the remaining option for investing in the publicly traded markets.

If you have a RRSP, TFSA, and non-registered investment account, your non-registered account is the best place for your bond ETFs.

This is particularly true if you invest in HBB.TO, the highly tax efficient swap-based ETF from Horizons. Here is the math to demonstrate why:


Dealing With the Large RRSP Issue

Despite common financial wisdom cautioning investors about big RRSPs, an aggressive and savvy investor should make it their goal to maximize the value of all their accounts including their RRSPs.

While a truly massive RRSP is not necessarily an easy thing to deal with from a tax perspective, don't be fooled into thinking you will automatically be stuck with a large tax bill that is so damaging you should have avoided large returns within your RRSP.

You can withdraw money from your RRSP and still be tax efficient. With some planning, you should be able to get money out of your RRSP nearly tax free.

The issue of RRSP size/tax liability is actually something I've changed my own mind on as I have learned more about aggressive (and still legal) tax planning.

For example, an aggressive tax planner can use several tactics to reduce their taxes on RRSP withdrawals in retirement. The main strategy would be creating interest expenses to offset your income.

The most aggressive way to do this is using your RRSP to borrow against your house for investing purposes. You may be able to withdraw tens of thousands each year from your RRSP completely tax free while technically remaining debt-free.

If you are open to taking on debt, you can take out a home equity loan for investing (like the end of the Smith Manoeuvre process) or invest with margin in your non-registered investment account.

You can also reduce taxes on your investment profits in your non-registered account by strategically harvesting capital gains to increase the adjusted cost base of your investments. This strategy can help you pay no taxes at all on your swap-based bond ETF, even when selling ETF units for a profit.

Don't be fooled by conventional planning tax fears. More money in your RRSP gives you more options. Better tax planning increases your overall net wealth. For these reasons, use your RRSP to buy growth assets like stocks (particularly foreign listed stocks) and worry about the tax issues on withdrawals later. Put your bonds in your non-registered investment account, but make sure you buy one of the more tax efficient bond ETFs to increase the true returns your bonds can provide.

Comments & Questions

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Comments containing links or "trolling" will not be posted. Comments with profane language or those which reveal personal information will be edited by moderator.