Tax Optimizing the Couch Potato Portfolio

I received an email from a reader questioning how to properly setup the Couch Potato Portfolio for maximum tax efficiency.  I have written about this topic before in my tax optimized portfolio allocation article, but I neglected to name specific examples.

What is the couch potato portfolio?  It’s a simplified index investing strategy that composes of 4 investments.  The 4 parts are made of a Canadian index, US index, International index and a Bond index.  To keep it extremely simplified, you have the option of keeping every investment in equal proportions.  To me, the bond allocation should be adjusted based on your risk tolerance – the higher your risk tolerance the lower bond allocation and vice versa. After the bond allocation is chosen, the remaining equities are divided equally.  At least that’s how I do it.

As index investing can be with mutual funds or ETFs (or a combination), a good example of a low cost mutual fund couch potato portfolio would be with the TD e-Series funds.  For arguments sake, lets assume a 40% TD-e bond index allocation, which means 20% would be the TD-e Canadian Index, 20% TD-e US Index, and 20% TD-e International Index.  If ETFs are your fancy, then a low cost ETF portfolio would be 20% XIU, 20% VTI, 20%, 10% VEA, 10% VWO, and 40% XSB.

What is porfolio allocation?  It’s how to optimally place various types of investments for the highest tax benefit.  For example, foreign dividends may face a withholding tax depending on which account it is held in.

For example, if you are an indexer, a simple portfolio may consist of globally diversified index funds/ETFs, bonds and cash.

Here are some possibilities on how to minimize your investment taxation providing that your tax sheltered accounts are maxed out:

RRSP:

  • Fixed Income/Bonds/GIC’s
  • Foreign Equities
  • Income Trusts
  • REITs

TFSA

  • Fixed Income/Bonds/GIC’s
  • Income Trusts
  • REITs

Non-Registered:

  • Canadian equities

As I mentioned above, if you have the contribution room in tax sheltered accounts (RRSP/TFSA), then it’s most tax efficient to keep your investments in those accounts.  However, if you decide to use your TFSA, then keep the foreign holdings (ie. US/international equities) within an RRSP as foreign dividends will face withholding tax (15%) in a TFSA.

However, if you don’t have the contribution room, then simply follow the guideline quoted above.  Here are some specific examples on tax efficient accounts to place your couch potato components:

RRSP:

  • Fixed Income/Bonds/GIC’s – TD-e Bond Index, iShares Short Term Bond Index (XSB)
  • Foreign Equities – TD-e International Index, Vanguard Total Stock Market (VTI), Vanguard Europe Pacific (VEA), Vanguard Emerging Markets (VWO)
  • Canadian Equities – TD-e Canadian Index, iShares Canadian Index (XIU)

TFSA

  • Fixed Income/Bonds/GIC’s – TD-e Bond Index, iShares Short Term Bond Index (XSB)
  • Canadian Equities – TD-e Canadian Index, iShares Canadian Index (XIU)

Non-Registered:

  • Canadian Equities – TD-e Canadian Index, iShares Canadian Index (XIU)

Not to beat this topic to death, but assuming that you use your tax refund wisely, simply keep everything in your RRSP.  If your savings exceed your contribution room, then move some of the fixed income or Canadian equities to your TFSA.  If you don’t have enough room in your TFSA, then move your Canadian Index to your non-registered account.

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FT

FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.
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Drew
7 years ago

What is the optimal allocation when you’re looking to invest at least 50% of your income?

You max out your RRSP and TFSA contribution quickly and everything else has to go into a taxable account. It’s clear that a TFSA is the best account for bonds, of the three.

Is it better to put VTI in your RRSP while VXUS and Canadian equity go into a taxable account, or vice versa with VTI and VXUS?

The US withholding tax portion of both VTI and VXUS is recoverable from taxable accounts. So does it matter which is sheltered and which is taxable? You’ll save the US withholding tax and pay the international portion either way, right?

Trevor
8 years ago

This is a great article! One quick question please. I am putting together a complete couch potato and it only hold 20% Canadian equities (which should go into my non-registered account). However, my investment room is only about 50/50 registered/non-registered.

What would then be best to move into the non-registered portion – the Canadian bonds? Assuming lowest yield then this would trigger the least capital gains correct? Thank you.

Paul
10 years ago

I just found this post, and have a simple question.

How are REITs taxed ? Is it the same as interest ? (ie, no capital gains or dividend breaks…).

I want to add a REIT or two to my portfolio, and want to optimize my after-tax revenue (especially since I’m just going for some plain indexing and a few dividend stocks)

PS: Love your blog, very interesting read !

Financial Cents
10 years ago

Thanks for the reply Frugal, I will let you know what I find out!

Financial Cents
10 years ago

Hey Frugal,

Good post! (Sorry, I’m late to the commenting party.)

Question to you and your faithful followers:

Do you know if RSP LIRAs (Locked-In Retirement Accounts) also have withholding taxes applied to them?

I can’t find much “out there” on the net about this…

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

I have my RSP LIRA since I had a pension with my former employer.

Cheers!

Simon
11 years ago

This was my email! Thanks a bundle for writing an article about it.

anon_reader
11 years ago

Hopefully the admin won’t mind me linking to another financial blog. No disrespect to anyone.

http://www.canadiancapitalist.com/how-withholding-taxes-affect-the-choice-of-international-investments/

Jug
11 years ago

So I followed the original Money Sense global couch potato, and put a 40/20/20/20 spit into XBB/XIC/XIN/XSP and its all in my TFSA. Will I be subject to any withholding tax, or not because my XSP and XIN are hedged to Canadian dollars?