Q. What are the pros and cons of holding the new Vanguard asset allocation ETFs in a TFSA? Are there any tax implications that would make it more favorable to hold these ETFs in a different type of account?
— Joe S.
A. Vanguard’s newly launched asset allocation ETFs allow investors to build a diversified portfolio with a single fund. There are three flavours: conservative (40% equities and 60% bonds), balanced (60% equities) and aggressive (80% equities), and each one offers instant global diversification, low cost, and convenience, as all the rebalancing is done for you.
RELATED: Best ETFs 2018 – One-stop portfolios
Joe, I think these ETFs are ideally suited to TFSAs for several reasons. First, because of their limited contribution room and relatively young age (TFSA have only been around since 2009), TFSAs are often relatively small compared with RRSPs. It’s not very efficient to build and maintain a diversified portfolio of multiple ETFs with a five-figure sum, as trading commissions can really add up. So a single product like the Vanguard asset allocation ETFs can make this cheap and easy: if you max out your TFSA with a single $5,500 contribution, all you need to do is make one trade per year.
As for the tax implications, Joe, the TFSA is the ideal location in this respect, too. For starters, the bond component of the Vanguard asset allocation ETFs is likely to be quite tax-inefficient, so it’s best not to use these products in non-registered accounts if you’re in a relatively high tax bracket. In a TFSA, of course, all of the income and growth are tax-free.
RELATED: Best U.S. ETFs for 2018
Moreover, while there’s nothing wrong with using the Vanguard ETFs in an RRSP, there are some more tax-efficient options for these accounts. Dividends from U.S. and international stocks in these ETFs are subject to foreign withholding taxes in both TFSAs and RRSPs: my colleague Justin Bender estimates these will cost investors between 0.12% and 0.18% annually.
If you’re investing in an RRSP, using U.S.-listed ETFs rather than Vanguard’s one-fund solution can reduce or eliminate these foreign withholding taxes. In a TFSA, however, these taxes are unavoidable, so there’s no reason not to use the asset allocation ETFs: they’re as tax-efficient as any other option and a lot more convenient.
MORE ABOUT ASK AN INVESTMENT EXPERT:
- Can I contribute to a TFSA after giving up my U.S. status?
- How to rebalance when some ETFs already do it themselves
- My advisor wants me to invest $150,000 in seg funds. Should I?
- ‘Corporate class’ mutual funds are tax efficient. Why should I care?