Mailbag

Questions on Canceling Mortgage Life Insurance and Stock Ex-Dividend Date

July 20, 2009

8 comments

In today’s post, I’ll try and answer two more questions that were sent in to the Personal Finance Clinic. You may also want to check out Triaging My Way to Financial Success and Money Gardener for more questions that were sent in to the clinic.

Tony asks:

We currently have mortgage life insurance, but what I’ve been reading lately leads me to believe that it may not be the smartest decision. Are we better adding the value of our mortgage onto each spouse’s life insurance policy and canceling the mortgage life insurance?

The drawbacks of Mortgage Life Insurance were pointed out in an earlier post (See Mortgage Insurance versus Life Insurance). I think it makes sense to first obtain or increase an adequate amount of term-life insurance and after the policies come through, cancel the mortgage life insurance. A chat with a licensed insurance broker should clarify matters.

Bryce asks:

When buying a dividend stock or even a corporate bond, is it best to wait till a little before the dividend is paid out to buy the stock?

The short answer is no. This article on Investopedia explains terms such as declaration date, ex-dividend date, record date and payment date. Unfortunately, you cannot make more money by purchasing a stock before the ex-dividend date. The stock price will usually drop by roughly the amount of dividend payment on the ex-dividend date.

Withholding tax & TFSA Investments

June 16, 2009

30 comments

In today’s post, I’ll try and answer a question on the new Tax-Free Savings Account that were sent to the Personal Finance Clinic. You may also want to check out Money Gardener and Triaging my way to Financial Success, who have also been fielding questions that were sent to the Clinic.

Maxime writes:

I have opened a TFSA with BMO InvestorLine and purchased shares of Microsoft. When I received my first dividend I was surprised to see that they took the usual 15% of taxes as in a regular [taxable] account.

I called BMO to ask about it because I was sure that there would be no income taxes and they told me that this rule in TFSA applies only on Canadian investments.

Is it the same for you guys?

The TFSA is a true tax-free account. There are no taxes on interest, dividends or capital gains on investments held in the account. However, if Canadian residents purchase US-based securities (such as Microsoft) in a TFSA, a 15% withholding tax applies. The withholding tax has nothing to do with the Canada Revenue Agency. It is charged by US tax authorities on US investments held by foreigners, including Canadian residents. Withholding tax also applies to other tax-deferred vehicles such as RESPs.

RRSPs, on the other hand, receive special treatment under the Canada-US Tax Treaty because they are “operated exclusively to provide pension, retirement or employee benefits”. However, if you hold non-US foreign investments inside a RRSP, you may pay a withholding tax. For instance, I used to own Nokia (NOK), which is based in Finland, within my RRSP and was subject to a withholding tax.

As US investments held in a TFSA are subject to a withholding tax, it is best to hold these securities within a RRSP. The TFSA is an ideal location for Canadian bonds, Canadian stocks and Canadian income trusts, including REITs.

Personal Finance Clinic: Unbundling ETFs & XIN versus VEA

June 8, 2009

11 comments

In today’s post, I’ll try and answer two questions that were sent to the Personal Finance Clinic. You may also want to check out Money Gardener and Triaging my way to Financial Success, who have also been fielding questions that were sent to the Clinic.

Gaby of Toronto asks:

While ETF’s can provide some stability and peace of mind, would it be possible to do better by buying individually enough of an ETF’s main components that cover a big chunk of the holdings? For example, if the iShares Canadian Tech Sector ETF (XIT), is moving up, would it theoretically be possible to buy its top two or three components (Research in Motion, CGI Group Inc. – Class A, and Open Text Corp) and therefore weed out the smaller stocks holding the performance back?

You are talking about unbundling ETFs and buying the component stocks directly, which could work out cheaper due to $10 stock commissions and the concentrated nature of many sector ETFs. The StingyInvestor.com website has a nifty tool for comparing the cost of the ETF with buying the shares directly. If you are willing to live with the tracking error introduced when dropping some of the smaller names, unbundling the ETF could work out even cheaper.

Dennis from Toronto asks:

Are there any tax advantages/disadvantages in choosing iShares CDN MSCI EAFE ETF (XIN) over Vanguard Europe-Pacific (VEA)? I understand that the MERs are different and iShares hedges foreign currency exposure. However, are there different tax implications for choosing Vanguard versus Canadian iShares?

Yesterday’s post showed how holding Canadian ETFs that in turn hold US ETFs results in a withholding tax that cannot be recovered for registered holdings. In taxable accounts, ETFs such as XIN that hedge foreign currency exposure have a different problem: the gains due to currency hedging are taxed as capital gains on an ongoing basis. In other words, ETFs such as XIN that hold foreign ETFs have a tax leakage due to withholding taxes in RRSPs and a tax leakage due to ongoing capital gains in taxable accounts.