Archive for July, 2009

This and That: Retroactive TFSA Contribution Room, Financial Literacy and more…

July 30, 2009

  1. In a chat with Jon Chevreau, actuary Malcolm Hamilton proposes providing retroactive TFSA room to help seniors who have lost RRSP contribution room in the current bear market. While the proposal generated overwhelming support among older Canadians nearing retirement (check out these responses on the Wealthy Boomer), the younger crowd reacts coolly to the idea as the posts on this thread on Canadian Money Forum indicate.
  2. Ellen Roseman wonders if efforts to increase financial literacy work at all. Unfortunately, financial literacy is like waging an asymmetrical war. The financial firms can simply outspend schools and non-profits.
  3. Jason Zweig warns investors not to confuse economic growth with stock market returns. History suggests the two are negatively correlated.
  4. Statistics Canada reckons that Canada’s inflation rate is negative. Rob Carrick writes that he is experiencing significant inflation on many household expenses.
  5. Four Pillars says that spending cash is the same as borrowing if you have debts.
  6. Michael James says that Malcolm Hamilton’s proposal to boost TFSA contribution room amounts to a transfer of future wealth from young to the old.
  7. Million Dollar Journey weighs in on whether to pay off the lowest balance or highest interest debt first.
  8. In the light of the Earl Jones affair, Where Does All My Money Go? reminds investors to immediately check if their advisor is registered.
  9. The Dividend Guy Blog featured a post on the importance of reinvesting dividends.
  10. Chaya Cooperberg notes that the financial behaviour of our parents has a deep influence on how we handle our finances.

Scotia iTrade Review

July 29, 2009

[Scotia iTrade Logo]

When Scotiabank acquired the Canadian brokerage arm of E*Trade, the account I had opened with E*Trade to my participate in my employer’s Stock Purchase Plan was automatically converted into a Scotia iTrade account. The website remains much the same as it did under E*Trade except for some branding in the Scotia red colour and addition of research reports from Scotia Capital. As Scotia iTrade is severing links with E*Trade, I thought I’d write a review while I still have an account with them.

Administration Fees and Commissions
Scotia iTrade’s biggest attraction is the low fees, which are lower than that of the big bank brokers but higher than deep-discount brokers such as Questrade (See: Questrade Review) for accounts of modest size. There is no administration fee on registered accounts such as RRSP, RESP or TFSA but watch out for the rather steep low-activity fee of $50 per quarter charged to taxable accounts.

Investors looking for a competent discount broker would find iTrade’s commission structure to be middle of the pack. iTrade charges a commission of $19.99 for most trades but household accounts that total more than $50,000 qualify for trades costing $9.99.

Ease of Funding
Clients can take advantage of the free Electronic Fund Transfer (EFT) facility to move funds between their Canadian or US Dollar bank account and Scotia iTrade account. Note that there is no integration or direct link between Scotia iTrade and Scotia Bank accounts just yet.

Parking Cash
While the Cash Optimizer account pays a competitive rate and can be used to park cash temporarily from taxable accounts, there is no place to park the cash in registered accounts. Scotia iTrade does offer mutual funds but all funds held for less than 90 days are charged a 1% penalty.

Currency Conversion Fees
The currency fees at Scotia iTrade are rather steep. In a phone call today, I was quoted a US dollar buying rate of 1.0665 and a selling rate of 1.1055 for a spread of 3.6%, which is almost double the typical fees. Fortunately, iTrade has kept the wash trading capability introduced by E*Trade (See: E*Trade Quietly Offers Limited Wash Trades).

Guaranteed Income Certificates
While GICs are available, clients have to phone in to purchase or request quotes. The rates on GICs appear to be competitive.

A cursory check shows that iTrade has a decent inventory of bonds. The pricing seems to be slightly better than RBC Direct Investing, our main brokerage. For instance, a 5% Government of Canada bond maturing on 01-June-2014, yields 2.606% on iTrade and 2.512% on RBC Direct.

Mutual Funds
iTrade offers more than 3,200 mutual funds from all major vendors. There are no commissions to buy or sell.

Scotia iTrade is not my primary broker but I have used E*Trade for many years and found them to be a competent broker. Bank of Nova Scotia has so far kept E*Trade as is with only minor changes — a splash of red on the webpage and the addition of analyst reports from Scotia Capital come to mind. Investors who do not yet qualify for low commissions at the big bank brokerages will probably find iTrade at or near the top of their list. If you are an iTrade client, I would love to hear from you in the comments section.

The best location for Canadian Dividend Stocks

July 28, 2009


The question of whether the best location for Canadian Dividend Stocks is a taxable account for some provinces and tax brackets comes up regularly. As eligible dividends from Canadian stocks generate a non-refundable tax credit and reduce taxes owing in some tax brackets in all provinces, it seems logical that a taxable account would be an ideal location for holding Canadian stocks for some tax payers. For instance, dividends received by Ontario residents with a taxable income of less than $36,848 receive a dividend tax credit at the rate of 7.71% of eligible dividend received.

Before diving into the numbers, let’s make some assumptions: a pre-tax investment of $1,000 providing a return of 10% when held for 10 years. If the investment is held in a RRSP account, it is withdrawn at the end of ten years and taxes paid at the marginal tax rate. If the investment is held in a taxable account, taxes on dividends are paid every year but the investment is sold and capital gains tax paid at the end of the holding period. We’ll also make comparisons for the income, capital gains and dividend tax rates for all the Ontario tax brackets (Source: Ontario tax brackets from

Ontario Tax Brackets for Income, Capital Gains and Dividends
  Income     Capital Gains     Eligible Dividends  
 First $36,848  21.05% 10.53% -7.71%
 Upto $40,726  24.15% 12.08% -3.21%
 Upto $64,882  31.15% 15.58% 6.94%
 Upto $73,698  32.98% 16.49% 7.44%
 Upto $76,440  35.39% 17.70% 10.94%
 Upto $81,452  39.41% 19.70% 12.91%
 Upto $126,264  43.41% 21.70% 18.71%
 Over $126,264  46.41% 23.20% 23.06%

First let us compare a RRSP account with a taxable account for non-dividend paying stocks. If the applicable tax rate is TR% and the investment is held within a RRSP, it will be worth $1,000 * 1.1 ^ 10 * (1-TR). Since investments made in a taxable account with after-tax cash, the initial investment in a taxable account is $1000 * (1 – TR). If capital gains are taxed at the rate of CR%, the investment held in a taxable account will be worth initial investment plus investment growth left after paying taxes on capital gains: $1000 * (1-TR) + $1000 * (1-TR) * (1.1^10-1) * (1-CR). Here are the results:

Difference between RRSP and Taxable Account for Non Dividend Payers
  RRSP Account     Taxable Account     Difference  
 First $36,848  $2,048 $1915 $132
 Upto $40,726  $1,967 $1,821 $146
 Upto $64,882  $1,786 $1,615 $171
 Upto $73,698  $1,738 $1,562 $176
 Upto $76,440  $1,676 $1,494 $182
 Upto $81,452  $1,572 $1,381 $190
 Upto $126,264  $1,468 $1,272 $196
 Over $126,264  $1,390 $1,192 $198

The results probably don’t suprise most of you. If anything, the results probably understate the advantage of a RRSP because most taxpayers will be in a lower tax bracket in retirement than in their working years. Even though withdrawals from a RRSP are taxed at income tax rates, which is double the tax on capital gains, a RRSP is probably the best location for non-dividend paying stocks. Note, however, that RRSP withdrawals might affect income-tested benefits such as Old Age Security and Guaranteed Income Supplement more than capital gains.

Now, let’s look at what happens when the entire return from an investment is in the form of dividends. Inside a RRSP, it makes no difference whether the returns are in the form of capital gains, dividends or a mixture of both. The analysis of a taxable account is also relatively straightforward: the rate of return is adjusted to reflect the taxes on dividends. At the end of the holding period, an investment that exclusivlely pays dividends will be worth $1,000 * (1-TR) * ( 1.1 * (1-DR) ) ^ 10, where DR is the dividend tax rate.

Difference between RRSP and Taxable Account for Pure Dividend Payers
  RRSP Account     Taxable Account     Difference  
 First $36,848  $2,048 $2,204 -$156
 Upto $40,726  $1,967 $2,028 -$61
 Upto $64,882  $1,786 $1,671 $114
 Upto $73,698  $1,738 $1,619 $119
 Upto $76,440  $1,676 $1,510 $166
 Upto $81,452  $1,572 $1,390 $182
 Upto $126,264  $1,468 $1,228 $240
 Over $126,264  $1,390 $1,116 $274

The results show that taxpayers in the lower tax brackets have some justification for holding dividend payers in a taxable account. However, though the taxes on dividends are lower than the taxes on capital gains, a taxable account is leakier for dividends than for capital gains for investors in the top tax brackets. If you think about it the reason is clear: since dividends are taxed regularly, even if it is at slightly lower rates, the effect of compounding is lost somewhat.

Unfortunately, it is rare to find investments that provide returns exclusively via dividends. In actual practice, investment returns are a mixture of dividends and capital gains. Assuming that 60% of the returns are obtained through capital gains and 40% through dividends, let’s look at how our hypothetical investment would perform in a RRSP account and a taxable account. As the analysis cannot be boiled down into a neat formula, I broke down the annual returns from capital gains and dividends, tracked the changing book values and market values and computed after-tax returns in a spreadsheet (available on request, if you want to double-check my results). It would be logical to guess that the results would fall somewhere in between the results of purely capital gains and purely dividends:

Difference between RRSP and Taxable Account for Typical Dividend Payers
  RRSP Account     Taxable Account     Difference  
 First $36,848  $2,048 $2,025 $23
 Upto $40,726  $1,967 $1,902 $65
 Upto $64,882  $1,786 $1,640 $146
 Upto $73,698  $1,738 $1,588 $151
 Upto $76,440  $1,676 $1,503 $173
 Upto $81,452  $1,572 $1,388 $184
 Upto $126,264  $1,468 $1,258 $210
 Over $126,264  $1,390 $1,164 $226

The answer isn’t as clearcut anymore. Even for the lower tax brackets (ignoring the effect of RRSP withdrawals on income-tested benefits), a RRSP comes out marginally ahead of a taxable account for the typical dividend paying stock. The notable exception is British Columbia, which provides a generous 14.36% tax credit on dividends. A BC resident in the lowest tax bracket holding a purely dividend paying stock in a taxable account would return $304 more than a RRSP account (about double that of Ontario). A stock returning a mixture of dividends and capital gains would return $32 more in a taxable account than a RRSP account. So, unless you are a BC resident in the lowest tax bracket, you might find that a RRSP is still the most efficient location for typical dividend-paying stocks.

(PS: Also check out the following articles which compared investments located within a RRSP with those in taxable accounts.
Is an RRSP contribution better than a non-registered investment or a mortgage payment? from Efficient Market Canada.
The Retirement Savings Debate from PH&N)