Originally Posted by dmpi
If you do hold Foreign stocks try to hold them outside of a 401K or IRA so you can claim the Foreign tax credit on your income tax.
Originally Posted by Ed_The_Gypsy
All of my international equities are in a tax-protected account and that does have an impact. Often, an international stock will have 30% of the dividends withheld as taxes in the country of origin (e.g., RDS-A). I can't get credit for those taxes, but fortunately foreign companies often pay higher dividends than US companies.
Be wary of this assumption. I used to also blindly assume this, but then I started doing some calculating.
Assuming your income tax rate is lower in retirement than now, and assuming the foreign taxes aren't that high, it's better to hold your highest "effective taxable yield" (equating qualified dividends to non-qualified) in tax deferred/ROTH accounts.
There are many ETFs holding foreign stocks that pay dividends which are unqualified. This means you are effectively 'doubling' the tax hit of your dividend yield. (ex. a stock/ETF that yields just 2% non-qualified dividends has the same taxes owed as a stock/ETF that yields 4% and pays out qualified dividends!)
Since I hold many individual stocks and ETFs, and my goal is to produce an income-generating portfolio for my eventual ER, it's more of a factor for me than for a Boglehead.
Which do you hold in your taxable?
Assume marginal federal income tax bracket of 28%, state income tax bracket of 6%.
ETF "A" pays out 6% yield, but only 1/3 of the dividends are qualified, and withholds 10% foreign income tax.
6% dividend, 10% foreign tax withheld = 0.60% foreign tax withheld
2% of that yield is qualified (taxed at 15% max fed/6% state in the US = .42% taxes)
4% of that yield is non-qualified (taxed at full marginal income tax rate in US = 1.36% taxes)
Total Federal/State taxes = 1.78% less 0.60% FT credit = 1.18% net tax
ETF "B" pays out 3% yield, with 100% of the dividends are qualified, with no foreign income tax.
3% qualified dividend = 0.63% net tax
It might not look like a big difference....but multiply it by 20-30 times over 20-30 years, and multiply it another 50 times for 50 positions, and you're starting to add up some real money.
I set up a spreadsheet with 2 tables, 3 columns per table:
% qualified dividends
% foreign taxes withheld
For $1 in dividends from a stock, I then calculate the net after-tax dividend for taxable, tax-deferred, and then ROTH accounts.
I then put the same info on a contrasting stock in the other table to see which combination of holding them in which accounts produces the highest net after-tax money.
For me, if the foreign tax withheld is about 15% or greater, AND if the dividend is mostly qualified, then it makes sense to hold the stock/ETF in taxable. However, because qualified dividends are taxed at HALF of non-qualified, any foreign holding that has more than 50% non-qualified is in tax-deferred/ROTH, because losing the foreign tax credit is dwarfed by the higher taxes at the marginal tax rate.
For the few countries that withhold like 30% foreign taxes (Sweden?), it can make sense to keep it in taxable, but most of my foreign holdings that pay high yields (more than 3% or so) are in tax-deferred, since I have many domestic holdings that yield nothing or just 1%-2% and are qualified.
The one thing you have to keep in mind is that short-term capital gains distributions from ETFs are recorded as dividends/taxed at marginal rates, so you have to go to the Fund Sponsor and download their end-of-year tax summaries to see what % of the dividend is truly "dividends", and what is short-term capital gains...some of the sponsors like SPDR, iShares and Global X are pretty good about breaking that out, but others like VanEck don't tell you.
Also, keep in mind different countries have different rules, and a few stocks have dividend 'options':
Originally Posted by Ed_The_Gypsy
I realize this isn't too common, but RDS actually offers shareholders the option of receiving dividends in shares rather than cash, in order to get around the high tax-withholding of their native European country. The trick is you have to tell your broker that you want to sign up for this (I use TD Ameritrade, and I don't have foreign taxes withheld on my RDS dividends, whether it's in a taxable or retirement account, but I had to e-mail them about it).
Also, a few countries like Canada (they might be the only ones?) actually have legislation to NOT withhold foreign taxes if your holdings are in qualified retirement accounts, while they DO withhold foreign taxes if you hold it in a taxable account (note: I just transferred some Canadian stocks to my retirement accounts, so I can't personally vouch for this working yet...but I have seen printed statements clarifying this).