You pay foreign withholding tax on an unregistered account, but you can claim an offset credit in your tax return. (The amount you paid will be shown on the T-slips you received at tax time.)
What is going where
OK, time to answer the burning question: which assets should be held in which accounts? There are few hard and fast rules, but here are some guidelines.
■ Fixed Income. Interest-bearing investments have the worst tax treatment, as all (or almost all) of their income is fully taxable and taxed at the highest marginal tax rate. So you want to keep them in tax-privileged or tax-free accounts as much as possible. Think of it this way: Fixed-income investments tend to generate less income and generate higher tax rates.
In fact, most bonds haven’t done well these days. Why? Interest rates have been trending downward for more than a decade, so most of the bonds in the market today were issued when interest rates were higher. Because the prices of bonds rise when yields fall, these bonds now trade at a premium (that is, their price is higher than their face value). At maturity, the bond holder suffers a loss of capital.
When you hold premium bonds in a taxable account, you will be hit by a double blow, says Justin Bender, portfolio manager at PWL Capital in Toronto. “Investors pay the full marginal tax rate on high-yield income while only receiving half the tax benefit of losing capital – and only if they have capital gains to offset.” Virtually all pension funds and ETFs are currently crammed with premium bonds, Bender says, and that is they will be for a long time to come, even if interest rates rise gradually. There are many types of bonds, however, and not all risks are created equal.
GICs are predictable and tend to be easier to understand than a bond. The first thing to note is: “GICs are interest rate sensitive and have a positive correlation with interest rates, which means that GIC rates rise when interest rates rise,” says Markou. “Plus, when interest rates go down, GIC rates go down.”
In the case of bonds, these investments are also interest-rate dependent, but negatively correlated, says Markou. So when interest rates go down, bond values go up. In addition, the value of bonds can fall when interest rates rise. This is important for those who are considering investing in bonds in the future. The different types of bonds include: Provincial, Canadian (both government), and Corporate / Commercial.
Are Bonds Better? Over the past decade, some bonds have outperformed GIC as rates have come down (and show no signs of rising). But it depends on the rate of return and your needs. Bonds are liquid, but GICs are always sold at face value – never at a premium – so you don’t get hit by the double blow of high interest payments followed by capital losses. Both have risks due to interest rates and inflation. Bonds can also experience capital losses when bought at a premium and sold for less than face value. Some bonds can also pose credit risk.