Whether you're a citizen or non-citizen of the United States, you may have wanted to buy US based investment products like stocks and ETFs. After all, the US is the biggest economy in the world, with one of the highest growth markets.
Adding US based stocks to your portfolio helps you diversify while giving you access to one of the strongest markets with the highest returns.
Nowadays, it's easy to invest in US based securities through your local stock broker. If you're a resident of the US, ordinary dividends are taxed like normal income.
However, if you're a non-resident of the US, you will be subjected to heavy taxes imposed by the US on your earnings, which cut into your returns.
Let's explore more about what this means and the ways that we can reduce this withholding tax in order to increase our returns.
What is the US dividend withholding tax?
If you're unsure about what dividends mean, do check out our explanation here first. The US dividend withholding tax is a tax imposed on foreigners on the interests and dividends paid by a corporation to its shareholders.
Note that this tax applies for foreigners (non US citizens) only. If you're a US citizen, you will be subjected to the US's normal tax laws, which include paying normal income taxes on ordinary dividends and interests. For non US citizens, the tax situation is a little different.
While the US does not tax non-citizens on capital gains (the increase in value of your holdings compared to when you bought it), the US does impose a 30% dividend withholding tax on dividends and interests.
This means that if your US stock pays out a dividend of $1 per share, you would effectively only get $0.7 per share after the dividend withholding tax! As you can see, it heavily reduces your returns, especially if you're a value based investor.
In addition, it is not only shares that are taxed. Effectively, any investment product that pays out dividends or interests will be taxed. These include, but are not limited to bonds, shares, ETFs, REITs and more.
The actual percentage that you are taxed on dividends and interests depends on which country you are from.
For example, in Singapore, we will have to pay the full 30% dividend withholding tax if we purchase US based investment products with our local brokers. This is because Singapore does not have a tax treaty with the US.
If you're from Canada, however, you will only have to pay a 15% dividend withholding tax on US investment products. This is because Canada has a tax treaty with the US that reduces the income tax!
To check if the country you are a citizen of has a tax treaty with the US, click here. If your country is on this list, you have a tax treaty with the US. Open the treaty and click on dividends to check the exact percentages that you have to pay.
If your country is not on this list however, then you probably don't have a tax treaty with the US and are subject to the full 30% in dividend withholding tax.
This could really accumulate to a very large sum if your dividends are large, and hurts even more in the long term as every single dividend you receive is taxed.
For example, if you were to buy 1000 AT&T shares at $29.50, and $0.52/share in dividends were declared to be paid out quarterly, you would technically get $2,080 worth of dividends every year.
After the dividend withholding tax however, 30% vanishes, dwindling to $1,456 a year. You are losing out on $624 annually. In 10 years, you would have lost $6,240 in dividends to the dividend withholding tax!
The dividend withholding tax hurts. But luckily, there are some ways to circumvent or reduce its impact while still investing in the US, one of the most diverse and high growth markets in the world.
Dodging the dividend withholding tax
Focusing on growth stocks
Nothing illegal here. This is a method that avoids the withholding tax completely, although it requires some concessions on your part. Remember that the US doesn't tax non-citizens on capital gains.
As such, you can choose to concentrate your investments in the US on growth products only. This means that you would focus on US investment products that give none or barely any dividends, reinvesting their profits back into the company in order to promote more growth.
In this way, you would shift your focus of returns into getting capital gains, which do not suffer from the dividend withholding tax.
This actually helps in diversifying your portfolio a little. A popular method here in Singapore is to:
1. Buy local dividend stocks
2. Buy US growth stocks
Depending on your country, you may find that your local stocks are not subjected to dividend withholding taxes, as in the case of Singapore. In Singapore, there are no shortages of stocks that return high dividends. Some examples include bluechips such as DBS (SGX:D05), Singtel (SGX:Z74), as well as REITS such as CapitaMall Trust (SGX:C38U).
As such, you may simply use local stocks to grow your dividend-paying side of the portfolio, and use the US to diversify and go for high growth stocks to balance it out.
Since the US has a much larger market than Singapore, the growth of US companies is likely to be faster and greater than that of Singapore companies. It is, after all, the financial hub of the world. Therefore, it would be a sound strategy to focus on growth stocks in the US.
Similarly, in a small country like Singapore, the prospects of growth are lower since the market size is smaller. Since growth and expansion can be difficult, most companies here tend to pay out a majority of their profits as dividends instead to attract investors instead of reinvesting them into growth. As such, focusing on dividend returns instead of capital gains is a sound strategy in Singapore.
Of course, this depends on the country you are based in. It is best to have both types of stocks (growth and value) for diversification but depending on your risk appetite, you can choose to have more of one type of stock and less of the other. Click here to find out more!
Nuances of the dividend withholding tax
Before we dive deeper, it is important to know that dividend withholding taxes are imposed based on where the company is domiciled, and not where the company is listed. In other words, not all stocks that are listed in the US stock exchange are subjected to a 30% dividend withholding tax!
Companies that are listed in the US but whose business operations take place in another country are not subjected to the 30% dividend tax. However, this does mean that there are completely no taxes. Instead, you will be subjected to that country's taxes.
For example, Nokia is listed on the New York Stock Exchange which is in the US but is actually domiciled in Finland. Hence, dividends earned from Nokia will not be subjected to 30% dividend withholding taxes. Instead, you will be subjected to Finland's 10% dividend withholding tax on non Finland citizens which is much lower.
Now that we understand how a stock listing's country of domicile can change the amount of dividend withholding tax that we pay, let's see how we can use it to our advantage.
Reducing the dividend withholding tax
Investing solely in US domiciled growth stocks may not sit well with everybody. After all, there are many attractive dividend paying companies in the US with high growth but also have an attractive dividend payout, such as Johnson and Johnson (NYSE:JNJ) and Microsoft (NASDAQ:MSFT).
In light of such situations, how can we go about improving our returns if we wish to purchase such stocks or investment products?
As we have observed above, we can find companies and investment products that are actually domiciled in other countries instead of the US to enjoy a cheaper dividend withholding tax based on the country of domicile. This works even if that company operates primarily in the US.
In addition, the US has tax treaties with several countries, allowing citizens of those countries to enjoy a discount on the dividend withholding tax if they purchase US investment products.
And then, those countries also have tax treaties with other countries. In other words, even if your country doesn't have a tax treaty directly with the US, you can use those countries that do have a tax treaty with the US as a proxy to gain the benefits.
Confused? Let's look at an example. Let's say I wish to purchase an index fund that tracks the S&P 500, a collection of 500 of the largest companies in the US.
If I buy it direct from a US exchange like NASDAQ, I would have to pay 30% in dividend withholding taxes since I'm in Singapore, a country that doesn't have a tax treaty with the US.
- US -> Singapore:
30% dividend withholding tax
Meanwhile, Ireland has a tax treaty with the US, allowing them to only have to pay 15% in dividend withholding taxes instead of 30%. This means that any Ireland ETFs that hold US stocks only have to pay 15% dividend withholding taxes on those stocks due to the tax treaty.
- US -> Ireland:
15% dividend withholding tax
Finally, Singapore and Ireland has a tax treaty that allows us to purchase Ireland domiciled products with 0% taxes.
- Ireland -> Singapore:
0% dividend withholding tax
- US -> Ireland -> Singapore:
15% dividend withholding tax on US -> Ireland shares only
As you can see, a Singaporean could purchase Ireland domiciled investment products to use Ireland as a proxy in order to reap the benefits of the tax treaty between Ireland and the US.
Why Ireland domiciled ETFs?
As a long term investor, we are primarily interested in stable investment products with long term gains. The US has plenty of ETFs that track many indexes with good stable and low risk growth prospects. Therefore, they are very attractive as a long term investor for diversification. Read more about why we love ETFs here.
The next question is - why Ireland? For many non US resident investors, there may be plenty of other countries in a tax treaty with the US that you can use as a proxy to reduce the dividend withholding taxes.
However, investors like Ireland mainly due to the liquidity. Most Ireland domiciled investment products on listed on the London Stock Exchange (LSE), one of the largest stock exchanges in the world behind the US's stock exchanges.
Therefore, if you buy an Ireland domiciled investment product, you can take advantage of the number of people trading on the London Stock Exchange to ensure that there is sufficient volume behind the product.
This is especially important in the case of ETFs. Since ETFs track an index, they require sufficient volume and liquidity in order to track the indexes properly. If an index drops, the ETFs must be able to buy/sell its underlying assets fast enough to follow the changes.
This is where the benefits of volume come in, and why Ireland domiciled investment products which are listed on the London Stock Exchange are a good choice due to their high volume of trading.
In addition, the tax treaty between Ireland and US helps us avoid another lesser known tax - the US federal estate tax. Under this tax law, if you hold US assets above $60,000 in value and die, you will be taxed 40% on all US assets you hold. That's a lot!
Of course, most people just don't pay it and the US doesn't really keep track of it, but it's something to take note of. Ireland and the US has a tax treaty that waives this 40% estate tax, meaning you get to keep all Ireland domiciled assets you bought that hold US assets even after death without being taxed.
Now that we've established why Ireland is attractive as a proxy for non US resident investors, let us introduce some Ireland domiciled ETFs to help you take advantage of the tax treaty.
Ireland domiciled ETFs
We will introduce the main Ireland domiciled ETFs that investors like to improve their portfolio diversification while taking advantage of the tax treaty to minimize the US dividend withholding tax.
When investing in ETFs, we mainly take note of two things - the expense ratio and the underlying assets.
The expense ratio is the percentage amount that you pay in fees to the ETF manager for them to manage the ETF. Obviously, the lower the better.
The underlying assets include the shares that the ETF holds. This is important since we get to see what the ETF is based on, which could affect the returns we get.
The ETFs we are about to introduce are mainly provided by either Blackrock or Vanguard, two of the largest investment firms in the world. We will provide the ticker symbols for the corresponding ETF below provided by both these firms.
There are not much differences between the two, but the key one is that the two firms' ETFs may track different underlying markets, which we will examine later on.
A lot of people prefer Blackrock (iShares) due to the higher volume since they have been around longer, which is important as mentioned above. However, you can choose either option depending on your preferences.
S&P 500 ETFs
Investors like the S&P 500 since it constantly holds 500 of the best companies in the US, and is highly diversified, making it a good indicator of the US economic health. Buying this ETF is like buying shares from all 500 companies at one go, making it very good for portfolio diversification.
The S&P 500's price has steadily increased over the years, providing tremendous growth over time for a long term investor. You can't really go wrong investing in this ETF if you would like to track the US's economy.
ETFs come in two kinds, accumulating and distributing. Accumulating (acc) means that dividends are automatically reinvested back into buying more shares in the ETF instead of being paid out to you, while distributing (dist) means that dividends are paid out to you as they come in.
Accumulating dividends with automatic reinvestment can be beneficial since you won't incur additional commissions if you want to reinvest your dividends. In fact, it is often recommended to reinvest your dividends to further increase the exponential growth of investing.
However, note that the dividends are taxed before being reinvested.
Remember the 30% dividend withholding tax? Whether you choose accumulating or distributing ETFs, instead of buying US-domiciled S&P 500 ETFs from the US stock exchanges and getting taxed 30%, we want to buy them from the London Stock Exchange as they are Ireland domiciled, allowing you to be taxed only 15% on the dividends.
The Ireland domiciled versions track the same S&P 500 by having the same top 500 US companies in the ETF's holdings, but they have the added benefit of only paying 15% in dividend withholding taxes on all of those shares.
Of course, they will not track the S&P 500 as accurately nor with as great a volume as the actual US domiciled S&P 500 ETFs, but you will get the dividend tax discount.
The table below shows the US domiciled version of the S&P 500 ETF and its corresponding Ireland domiciled version of the S&P 500 ETF. Note that these tickers are denominated in USD.
There are some tickers that can be in Great Britain pounds, which may provide less liquidity. Make sure to choose the ones traded on the London Stock Exchange.
|US-Domiciled S&P 500 ETF||Ireland-Domiciled S&P 500 ETF||Expense Ratio|
|VOO||Vanguard S&P 500 ETF||VUAA||Vanguard S&P 500 UCITS ETF (Acc)||0.07%|
|VUSD||Vanguard S&P500 UCITS ETF (Dist)||0.07%|
|IVV||iShares Core S&P 500 ETF||CSPX||iShares Core S&P 500 UCITS ETF (Acc)||0.07%|
|IUSA||iShares Core S&P 500 UCITS ETF (Dist)||0.07%|
As you can see, all the expense ratios are the same, and whether you choose Vanguard or iShares, they effectively both track the same underlying index - the S&P 500.
It doesn't really matter which one you pick. Just decide if you want accumulating or distributing dividends. Blackrock's ETF (iShares) also has a higher volume since it's been around longer.
If you want more liquidity and movement, go for iShares.
Some people may be looking for greater diversification than just the US. This is because there are no guarantees about the US economy in 10-30 years, while the world's economy as a whole is almost guaranteed to grow.
Additionally, investing in an ETF that tracks the whole world's markets is naturally much more diversified, even if the returns may not be as attractive as one that just tracks the US (although no one can predict the future). This is more attractive for investors with a lower risk profile.
The worldwide ETF also has the added benefit of including the US's economy in its tracking, so it technically does still track the US. If you buy this, you may not have to buy an ETF that tracks the S&P 500 as that would be like buying it twice.
The table below shows the US domiciled versions of ETFs that track the world's markets and the corresponding Ireland domiciled versions. Make sure they are listed under the London Stock Exchange.
|US-Domiciled World ETF||Ireland-Domiciled World ETF||Expense ratio|
|VEU||Vanguard FTSE All-World (No US) ETF||VWRA||Vanguard FTSE All-World ETF (Acc)||0.25%|
|VWRD||Vanguard FTSE All-World ETF (Dist)||0.22%|
|URTH||iShares MSCI World ETF||IWDA||iShares MSCI World ETF (Acc)||0.20%|
|IWRD||iShares MSCI World ETF (Dist)||0.50%|
|Special mention||SWRD||SSGA SPDR MSCI World UCITS ETF (Acc)||0.12%|
There is a key difference here. Note that Vanguard tracks "all-world" while iShares tracks "world". In this regard, iShares (Blackrock) and the SPDR one mostly tracks the developed world, while Vanguard decided to track everything, including emerging countries and markets.
This makes it so that Vanguard has greater diversification, but it may not be what you want. If you only want to invest in developed markets, then iShares would be the one for you, and vice versa if you truly want a representation of all worldwide markets.
Emerging markets ETFs
There are also people who want to leverage emerging markets to seek higher returns. In the future, these developing countries might grow to become economic powerhouses, so it's not a bad idea as well.
The table below shows the US domiciled version of ETFs that track emerging markets (EM) and the corresponding Ireland domiciled versions. Make sure they are listed under the London Stock Exchange.
|US-Domiciled EM ETF||Ireland-Domiciled EM ETF||Expense ratio|
|VWO||Vanguard FTSE EM ETF||VFEA||Vanguard FTSE EM ETF (Acc)||0.22%|
|VDEM||Vanguard FTSE EM ETF (Dist)||0.22%|
|EEM||iShares Core MSCI EM ETF||EIMI||iShares Core MSCI EM ETF (Acc)||0.18%|
|EIMU||iShares Core MSCI EM ETF (Dist)||0.18%|
Again, note that iShares doesn't include certain emerging markets while Vanguard does, which could result in differences in returns.
For example, VWO (Vanguard) returned 20.4%, while the iShares Core fund returned 17.5% in 2019. Read more here.
What Ireland-domiciled ETFs to buy?
The point of buying ETFs is mainly to diversify your portfolio. By buying an ETF, it is equivalent to buying small parts of a large basket of stocks, helping you to spread out your risk.
As such, when deciding which Ireland domiciled ETF to buy, the main idea is to look at your portfolio. How do you want to diversify your portfolio?
If you have a main concentration of US stocks, you obviously don't want to get more US stocks. If the US market suffers, you will be hit extra hard. Instead, consider diversifying the risk by getting emerging market ETFs.
Usually, the problem comes down to deciding whether to get an all-world ETF (e.g. VWRA) or combine an ETF that tracks developed markets and one that tracks emerging markets.
They both achieve the same thing - it's just between buying one ETF or two.
If you just want to buy one ETF and want worldwide diversification, VWRA might be for you. It tracks global markets (emerging and developed), but has an expense ratio that is a little high at 0.25%.
Note that VWRA only has 10.1% of its underlying index in emerging markets. If you want more than 10% in emerging markets, consider the next solution below.
If you are okay with buying two ETFs and still want worldwide diversification, then you might consider combining SWRD/IWDA + EIMI. The former will give you developed markets, while the latter will give you emerging markets. This will result in a lower expense ratio overall.
This way, you get to balance the percentage composition of developed to emerging markets in your portfolio by either buying or selling more of each ETF.
Of course, if you're purely looking into diversifying into US markets, you can't go wrong with getting an ETF that tracks the S&P 500. Since all expense ratios for these ETFs are the same, either get CSPX (for more volume) or VUAA (the new kid on the block).
Personally, I prefer accumulating ETFs so I don't have to worry about reinvesting dividends (and paying commissions again!), but you might want distributed dividends for more liquidity. The choice is ultimately up to you.
We have provided a list of Ireland domiciled ETFs for you to pick from if you're a non-US resident looking to buy US based ETFs and want reduced dividend withholding taxes.
However, one must be sure to do their own research before committing to a purchase. Whether the ETF is denominated in GBP or USD, the markets that it tracks, the country of domicile and so on all depends on your investment needs.
This article is mainly for Singapore investors, as going through Ireland is the most optimal method for us to purchase US shares and reducing the 30% dividend withholding tax to just 15%.
For Singapore investors, we have a handy guide if you would like to find out what brokerages would be the best fit for you to minimize your costs while trading Ireland domiciled ETFs and other investment products. Do check it out!
For other non US resident countries, your country may already have a tax treaty with the US and you can just buy US domiciled products directly, or you may have a better proxy to go through. A quick Google search should turn up the optimal proxy that you can use to reduce the taxes you have to pay to a minimum.
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