VOO and RRSPs: Why VOO Isn’t Subject to Withholding Tax in an RRSP

Navigating VOO, RRSPs, and Tax Implications

For Canadian investors exploring opportunities in the U.S. stock market, understanding the tax implications of their investment choices is crucial.

A common question that arises is: “Why isn’t VOO subject to withholding tax in an RRSP?”

This article delves into the intricacies of this topic, explaining the tax advantages and considerations for holding Vanguard’s S&P 500 ETF (VOO) in a Registered Retirement Savings Plan (RRSP).

Meta Description: Learn why VOO isn’t subject to withholding tax in Canadian RRSPs. Understand the Canada-U.S. Tax Treaty, compare account types, and explore currency conversion strategies for optimal investing.

Understanding VOO and RRSPs

Before we dive into the tax implications, let’s briefly review what VOO and RRSPs are:

VOO (Vanguard S&P 500 ETF)

• A U.S.-domiciled exchange-traded fund (ETF)
• Tracks the performance of the S&P 500 index
• Offers exposure to 500 of the largest U.S. companies
• Known for its low expense ratio and high liquidity

For more details on VOO, visit Vanguard’s official VOO page.

RRSP (Registered Retirement Savings Plan)

• A tax-advantaged retirement savings account for Canadians
• Contributions are tax-deductible
• Investment growth is tax-deferred until withdrawal
• Designed to encourage long-term savings for retirement

Learn more about RRSPs on the Government of Canada’s RRSP information page.

The Canada-U.S. Tax Treaty: A Key to Understanding VOO’s Tax Advantage in RRSPs

The cornerstone of VOO’s favorable tax treatment in RRSPs is the Canada-U.S. Tax Treaty. This bilateral agreement plays a crucial role in determining how investments are taxed across the border.

Key Points of the Canada-U.S. Tax Treaty:

1. Prevention of Double Taxation: The treaty aims to ensure that income is not taxed twice by both countries.
2. Encouragement of Cross-Border Investment: It provides incentives for Canadians to invest in U.S. markets and vice versa.
3. Special Provisions for Retirement Accounts: The treaty includes specific clauses that benefit retirement savings accounts like RRSPs.

How the Treaty Affects VOO in RRSPs

The most significant aspect of the treaty for our discussion is its treatment of U.S. dividends in Canadian RRSPs:

• U.S. dividends earned within an RRSP are exempt from the standard 15% withholding tax.
• This exemption applies to U.S.-domiciled ETFs like VOO.
• The result is that Canadian investors can receive the full dividend amount without immediate tax deductions.

For a deeper understanding of international tax treaties, visit the OECD’s resource on tax treaties.

VOO vs. VFV: Understanding the Domicile Difference

While VOO enjoys withholding tax exemption in RRSPs, its Canadian counterpart, VFV (Vanguard S&P 500 Index ETF), does not. Here’s why:

VOO (U.S.-Domiciled)

• Directly benefits from the Canada-U.S. Tax Treaty
• No 15% withholding tax on dividends when held in an RRSP
• Trades in U.S. dollars

VFV (Canadian-Domiciled)

• Holds units of VOO
• Subject to 15% withholding tax on dividends, even in an RRSP
• Trades in Canadian dollars

The key difference lies in the ETF’s domicile. VOO, being U.S.-based, qualifies for the treaty benefits directly. VFV, as a Canadian ETF holding VOO, doesn’t qualify for the same exemption.

For more information on the differences between these ETFs, check out our comparison article: VFV vs. VOO: What’s the Difference?

RRSPs vs. Other Canadian Investment Accounts

The withholding tax exemption for U.S. dividends is unique to RRSPs (and RRIFs) among Canadian investment accounts. Let’s compare how VOO is treated in different account types:

TFSA (Tax-Free Savings Account)

• Not recognized under the Canada-U.S. Tax Treaty for withholding tax purposes
• 15% withholding tax applies to U.S. dividends, including those from VOO
• Tax cannot be recovered

Non-Registered Accounts

• 15% withholding tax applies
• Can claim foreign tax credit on Canadian tax return to avoid double taxation

For a comprehensive comparison of registered accounts in Canada, visit the Financial Consumer Agency of Canada’s comparison tool.

Currency Conversion Considerations

While the withholding tax exemption is a significant advantage, Canadian investors need to consider currency conversion costs when purchasing VOO:

Standard Currency Conversion

• Most brokers charge a fee for converting CAD to USD
• These fees can range from 1% to 2.5% of the converted amount
• Over time, these costs can eat into the tax savings from the withholding tax exemption

Norbert’s Gambit

Norbert’s Gambit is a strategy to convert currency more cost-effectively:

1. Buy a stock or ETF that’s interlisted on both Canadian and U.S. exchanges (e.g., TD Bank)
2. Buy the Canadian-listed version with CAD
3. Ask your broker to “journal over” the shares to the U.S. side of your account
4. Sell the U.S.-listed version for USD

This method can significantly reduce currency conversion costs, especially for larger amounts. For a detailed guide on Norbert’s Gambit, read our article: What is Norbert’s Gambit and How to Do It.

Strategies for Optimizing VOO Investments in RRSPs

To make the most of VOO’s tax advantages in your RRSP, consider these strategies:

1. Lump Sum Conversions: Convert larger amounts of CAD to USD less frequently to minimize conversion costs.
2. Use Norbert’s Gambit: For significant investments, use this strategy to reduce currency conversion fees.
3. Long-Term Holding: The tax savings compound over time, making VOO particularly attractive for long-term investors.
4. Dividend Reinvestment: Many brokers offer dividend reinvestment plans (DRIPs) which allow you to reinvest dividends without additional currency conversion costs.
5. Regular Contributions: If making regular contributions, consider accumulating CAD and converting less frequently to reduce overall conversion costs.

FAQs

1. Q: Can I hold VOO in my TFSA? A: Yes, you can hold VOO in a TFSA, but you won’t benefit from the withholding tax exemption. The 15% withholding tax will apply to dividends.
2. Q: Is it better to hold VOO or VFV in my RRSP? A: From a withholding tax perspective, VOO is generally better in an RRSP. However, consider factors like currency conversion costs and your overall investment strategy.
3. Q: How does the withholding tax exemption affect returns over time? A: Over long periods, the exemption can lead to significant savings, especially when dividends are reinvested. However, the exact impact depends on dividend yield and growth rates.
4. Q: Are there any situations where VFV might be preferable to VOO in an RRSP? A: VFV might be preferable if you want to avoid currency conversion or if you’re making frequent, small purchases where conversion costs would be significant.
5. Q: Does the withholding tax exemption apply to all U.S. stocks and ETFs in an RRSP? A: Yes, the exemption applies to dividends from all U.S.-domiciled stocks and ETFs when held in an RRSP, not just VOO.

Conclusion

Understanding the tax implications of holding VOO in an RRSP can significantly impact your long-term investment returns. The withholding tax exemption provided by the Canada-U.S. Tax Treaty offers a valuable advantage for Canadian investors looking to gain exposure to the U.S. stock market through their retirement savings.

However, it’s crucial to weigh this benefit against other factors such as currency conversion costs, your overall investment strategy, and personal financial goals. While the tax savings can be substantial over time, they should be just one part of your broader investment decision-making process.

Remember, tax laws and treaties can change, so it’s important to stay informed and consider consulting with a financial advisor or tax professional for personalized advice.

Call to Action: Ready to optimize your U.S. investments in your RRSP? Consider reviewing your current holdings and exploring whether VOO aligns with your investment strategy. If you’re new to U.S. investing or currency conversion strategies like Norbert’s Gambit, consider reaching out to your broker for guidance or consulting with a financial advisor. Don’t forget to regularly review the CRA’s guidelines on foreign property reporting to ensure compliance with Canadian tax laws.