Top Tax Efficient ETFs in Canada for December 2024

ByDan Kent Published On:

Tax-optimized ETFs have been growing in popularity with investors seeking Canadian ETFs. These ETF varieties are engineered to limit tax implications on investors, employing methods such as following indices with low turnovers and steering clear of investments that yield high levels of taxable income.

In addition, these funds can hold distributions and reinvest them back into securities rather than paying the distributions out and creating a taxable event for investors.

By doing so, investors can keep more of their investment returns and potentially earn higher overall returns in the long run.

One of the main advantages of tax-efficient ETFs is their ability to reduce taxes on dividends. When an investor sells an ETF that has appreciated in value, they are typically subject to capital gains taxes. This is unavoidable in a taxable account most of the time.

However, with the distribution, the fund manager can choose not to pay any distribution out (none of the funds on this list do), and as a result, the investor doesn’t trigger any tax events.

Tax efficiency in ETFs

Tax efficiency is an essential consideration for Canadian investors when choosing an ETF. Tax-efficient ETFs are designed to minimize the impact of taxes on investment returns. There are several ways in which an ETF can be tax-efficient, including:

  • Capital gains: ETFs that minimize capital gains are tax-efficient. When an ETF sells securities for a profit, it generates a capital gain. If the ETF distributes these gains to investors, they will be taxed. ETFs that minimize capital gains can reduce the tax impact on investors.
  • Dividends and distributions: ETFs that distribute eligible dividends and capital gains are more tax-efficient than those that distribute interest income or foreign income. Eligible dividends and capital gains are taxed at a lower rate than interest income or foreign income. In addition, a fund can simply choose not to pay a distribution to the investor, eliminating a personal tax event.
  • Return of capital (ROC): ROC distributions reduce the adjusted cost base (ACB) of an ETF. This can result in higher capital gains when the ETF is sold. ETFs that minimize ROC distributions can be more tax-efficient.
  • Foreign withholding tax: ETFs that invest in foreign securities may be subject to foreign withholding tax. This tax is deducted at the source and reduces the ETF’s return. ETFs that minimize foreign withholding tax can be more tax-efficient.

Tax efficiency can have a significant impact on an investor’s after-tax returns. For example, if two ETFs have the same pre-tax returns, but one is more tax-efficient, the tax-efficient ETF will provide higher after-tax returns.

Investors should consult with a tax professional to determine the tax implications of investing in ETFs, as everyone’s situation is different, then one can determine what ETFs to buy in Canada. However, this article will tackle a few tax-efficient ETFs you can look at today and see if they’re a good fit.

What are the best tax-efficient ETFs in Canada today?

  • Horizons S&P/TSX 60 Index ETF (TSE:HXT)
  • Horizons S&P 500 ETF (TSE:HXS)
  • Horizons S&P/TSX Capped Composite ETF (TSE:HXCN)
  • Horizons NASDAQ-100® ETF (TSE:HXQ)
  • iShares S&P/TSX Capped Info Tech ETF (TSE:XIT)

Horizons S&P/TSX 60 Index ETF (TSE:HXT)

The Horizons S&P/TSX 60 ETF (TSE:HXT) is one of Canada’s most popular tax-efficient ETFs. This low-cost index fund ETF tracks the S&P/TSX 60 Index, which is made up of 60 of the largest and most liquid Canadian companies. 

The ETF has a low management fee of 0.04% and is designed to be tax-efficient using a total return swap structure. This structure allows the ETF to minimize taxable distributions to investors.

It has been around since 2010 and has nearly $3.3B in assets under management at the time of writing. Over the years, it’s caught on in popularity in a big way as investors are realizing the tax benefits of owning this fund in a taxable account.

Like every other ETF on this list, it does not pay a distribution. The fund’s strategy is to keep all capital inside the fund and allow investors to utilize the tax-advantaged capital gains over the long term.

Horizons S&P 500 ETF (TSE:HXS)

The Horizons S&P 500 ETF (TSE:HXS) is another popular tax-efficient ETF in Canada. This ETF tracks the S&P 500 Index, which comprises 500 of the largest U.S. companies. 

This S&P 500 ETF has a low management fee of 0.10% and is designed to be tax-efficient by also using a total return swap structure.

I’m not surprised the fees are a bit larger on this one. It’s a Canadian ETF that is tracking U.S. companies, so there will be larger underlying costs. I think 0.10% for a tax-efficient ETF that gives you exposure to the United States is minimal anyway.

With assets under management of just over $2B, it’s not as large as the TSX 60 fund. However, being Canadian ETFs, I’m not surprised by this.

Horizons S&P/TSX Capped Composite ETF (TSE:HXCN)

The Horizons S&P/TSX Capped Composite ETF (TSE:HXCN) is a tax-efficient ETF that tracks the S&P/TSX Capped Composite Index. Don’t confuse this fund with the TSX 60 fund listed above. They’re different.

Why? HXT tracks the TSX 60, the 60 largest companies in Canada. HXCN, on the other hand, aims to track the entire TSX Composite. Over the long term, HXCN has earned more returns, but it’s nearly negligible.

It has a management expense ratio of 0.05%, which is a bit higher than the TSX 60 fund but, again, negligible.

For someone who is debating between either HXT or HXCN, it boils down to the idea of whether or not you want to own the entire TSX Index or simply the 60 largest companies on it.

Horizons NASDAQ-100® ETF (TSE:HXQ)

The Horizons NASDAQ-100® ETF (TSE:HXQ) is a tax-efficient ETF that tracks the NASDAQ-100 Index. This index is made up of 100 of the largest non-financial companies listed on the NASDAQ. 

We have two funds on this list that give you U.S. exposure, one to the S&P 500 and one to the NASDAQ. These are ultimately the two most popular indexes in the country, and it’s not surprising that Horizons offers a product that caters to investors wanting exposure and mitigating taxes.

Because this NASDAQ ETF is a more niche ETF covering 100 companies on the NASDAQ, fees are much higher. Coming in at 0.28%, it’s the second-highest fee on this list (the next ETF I’ll talk about is the highest).

It has assets under management of $659M and is a relatively new fund, debuting in 2016.

iShares S&P/TSX Capped Info Tech ETF (TSE:XIT)

The iShares S&P/TSX Capped Info Tech ETF (TSE:XIT) is a tax-efficient ETF that tracks the S&P/TSX Capped Information Technology Index. This technology ETF is made up of Canadian companies in the technology sector.

XIT is the “blue chip” technology ETF here in Canada, as it allows an investor to grab virtually the entire Canadian tech sector in a single click. You’ll pay quite a bit for this ability, however. Management fees come in at 0.61%, more than 10 times as much as something like HXT. However, although returns are never guaranteed, it has put up exceptional performance relative to the TSX 60.

Remember that a purchase of XIT is a heavy bet on two of Canada’s tech darlings, Shopify (TSE:SHOP) and Constellation Software (TSE:CSU). Through our XIT ETF review we find they make up over half of the fund at the time of writing, with Constellation nearing 30%.

Choosing the right ETF for your investment Goals

Investors in Canada have a wide range of options when it comes to choosing the ETF for their investment goals. Risk tolerance, management fees, expenses, and commissions can all play a role in the decision-making process.

In addition to this, different accounts like the Tax-Free Savings Account (TFSA), of which there are various ETFs that are best for TFSA, Registered Retirement Savings Plan (RRSP), and non-registered accounts have various tax implications, especially once we start looking at Real Estate Investment Trusts, REIT ETFs, or U.S. stocks for our portfolios.

One of the first things to consider is the type of equity the ETF invests in. Canadian investors may want to consider ETFs that focus on Canadian corporations for the tax-friendly Canadian dividends, while those looking for more diversification may prefer ETFs that invest in a mix of U.S. and international equities.

Another important factor to consider is the management fee. While ETFs tend to have lower management fees than mutual funds, comparing fees between different ETF options is still important. 

Some ETFs may have higher management fees due to more active management or specialized investment strategies. We’ve gone over a few even on this list (XIT and HXQ).

Investors should also consider the tax implications on the distributions, even in an RRSP, of owning a Canadian-domiciled ETF that holds U.S. stocks or ETFs.

Ultimately, the right ETF for an investor will depend on their investment goals and risk tolerance. There are many different types of ETFs such as covered call ETFs, ETFs that focus on particular industries like gold ETFs, or other ETFs that offer broader diversification and exposure to several markets in all-in-one ETFs.

Those with a higher risk tolerance may prefer ETFs that invest in more volatile equities. In contrast, those with a lower risk tolerance may choose more stable options.

Finally, it’s essential for unitholders to regularly review their ETF holdings to ensure that they are still aligned with their investment goals. As the market and economic conditions change, some ETFs may become less suitable for an investor’s needs.

When choosing the right ETF, it’s critical to research, determine your risk tolerance, plan out your asset allocation, and consider all other relevant factors.