I’ve read that it’s a bad idea to buy ETFs in December. Why is that?
If you’re investing in a non-registered account, buying an exchange-traded fund (or a mutual fund) in December can lead to unpleasant tax consequences if the fund makes a year-end capital-gains distribution. You’ll end up paying tax on the distribution, even though, as a new unitholder, you didn’t participate in the gains that made the distribution possible.
Consider a simple example. Say you buy an ETF for $20 on Dec. 15, and a week later it declares a distribution of $1, consisting of net capital gains (capital gains minus capital losses) realized during the year. In most cases, these year-end capital-gains distributions aren’t paid in cash but are reinvested in the fund and do not affect the unit price.
So, all else being equal, you’ll still own an ETF worth $20, but you’ll have to pay tax at your marginal rate on half of that $1 capital-gains distribution. That’s why, if you expect that an ETF will make a year-end distribution, it’s best to buy the units on or after the ex-dividend date to avoid the tax hit. (The ex-dividend date is one day before the record date).
To help investors plan ahead, in November, ETF providers publish estimates of year-end capital-gains distributions for each of their funds. For example, estimates for iShares ETFs can be found at goo.gl/ufnjTS and information on BMO ETFs is available at goo.gl/f7vFi8. Mutual-fund companies also make estimates available, but you may have to contact the fund company directly if you can’t find the information with a google search.
If an ETF declares a distribution in December but pays it in January, in what year is the distribution taxable?
For ETFs, it is the record date that matters. If the record date is in 2018 but the payment date is in 2019, the distribution will be taxable in 2018. With stock dividends, on the other hand, the payment date determines when the dividend is taxable. A dividend with a payment date in 2019 will be taxable in 2019, even if the record date was in 2018.
I will not have enough cash to use up all $6,000 of my new TFSA contribution room in January. Can I transfer some of my stocks instead?
Absolutely. Just remember that, if you transfer shares in-kind to your tax-free savings account, it is considered a disposition and you are still responsible for paying tax on any capital gains (based on the difference between the price when the shares were transferred and the adjusted cost base of the shares). Unfortunately, if the shares have an unrealized loss and you transfer them to your TFSA, you are not permitted to claim the loss for tax purposes. In such cases, it may be better to sell the losing shares and contribute the cash to your TFSA. You could then wait 30 days to repurchase the same shares in your TFSA, or buy a similar, but not identical, security immediately. In either case you could claim the capital loss.
I need to withdraw cash from my TFSA for some expenses. Is it better to do it now or wait until next year?
If you withdraw the funds in 2018, the amount of the withdrawal will be added back to your TFSA contribution room as of Jan. 1. If you wait until 2019 to make the withdrawal, however, the contribution room won’t be restored until Jan. 1, 2020. Making the withdrawal in 2018 is probably your best bet.
Do you expect that we will get a Santa Claus rally this year?
I stopped believing in Santa Claus a long time ago. And I stopped believing in the Santa Claus rally last year when I asked a statistician to run the numbers. Despite the fact that December has historically been the strongest month for stocks on average, it turns out that December’s returns are not statistically different from any other month’s. In other words, like a coin that turns up heads several times in a row, it could be simply a product of chance and there is no evidence to suggest that December will outperform in the future. There’s no sign of St. Nick this year, by the way: As of Friday’s close, the S&P/TSX Composite Index was down about 4 per cent in December.
E-mail your questions to jheinzl@globeandmail.com.
John Heinzl