On a high level, even though you pay more tax with an ETF, your real rate of return isn’t much lower than stocks as stocks have higher purchase costs. This results in a somewhat comparable portfolio even though you will have paid more in taxes.

This post has been edited as when I first did the analysis, I forgot to drag the formula down to include the stock dividends. This resulted in ETFs winning in the comparison. That’s what you get for doing analysis at 10PM!

An added benefit of this blog is that my analysis and assumptions can be peer reviewed, usually within a day or so of posting. It’s so great to be part of an active community that’s as interested as me in finance.

Read on for the details.

ETF Pros:

• ETF’s are index funds which are made up of hundreds if not thousands of different stocks/companies. This gives huge diversification with little effort.
• They can be a set and forget and lazy investment option meaning you don’t need to read up on company performance reports and continually watch individual stocks.
• They have low fund management fees.
• They are cheap to buy in terms of commissions. Brokers often have some ETF’s which you can buy commission free.

ETF Cons:

• High taxes
  • 41% on gains
  • 41% on dividends
• Subject to 8 year deemed disposal rule
  • Reduces compounding effect
  • Increases tax filing burden
• They do not allow you to carry forward any losses to be used against future gains

ETFs are often down played or even avoided due to their high taxation in Ireland as well as their being subject to the deemed disposal rule.

A few years ago we used to have access to US ETFs which had a better tax treatment similar to stocks.

When I first started reading about investing I was annoyed that we no longer had this option and considered trying to replicate the ETF make-up manually by buying the top 10 stocks in each in order to avail of the better tax treatments.

This post will show why I’m no longer going to worry myself with this annoyance.

Deemed disposal

The concept of deemed disposals was brought in in 2006. The idea is that on the 8th anniversary of you holding an investment you must pretend to have sold it at the market value in that year. You must pay the exit tax on those gains.

This tax acts as a credit which you will use against your actual sale of the ETFs. If the market value is worth more when you sell than it was when you paid your deemed disposal, you will pay the difference. If it is worth less, you will get a refund.

If you hold distributing ETFs which pay out dividends each year, then you will need to pay taxes each year from year 1, regardless of if you reinvest those funds into the same ETFs or if you withdraw the cash for current use.

If you hold accumulating ETFs which automatically reinvest the dividends into the same ETF, you will need to pay the exit tax in the 8th year on both the gains and the dividends.

Worth noting is that exit tax was once as low as 23% from 2001-2008. Fund managers are lobbying to the government to bring the current rates of 41% back down at least in line with CGT and DIRT at 33%.

If this were to happen, ETF’s would fare better than stocks.

Stock Pros:

• Lower taxes:
  • 33% on gains
  • Marginal tax rate+USC+PRSI on dividends
    • You would need to be earning 120,000€ per person in order to have a net tax rate of 41% or higher so anything below this will mean you pay less on stock dividends than ETFs
• You can carry forward losses to offset taxes on future gains
• You get a tax exemption of 1,290€ on gains per year any year you sell stocks

Stock Cons:

• Expensive to purchase
  • 1% stamp duty on Irish shares, 0.5% stamp duty on UK shares. Some shares are exempt from stamp duty, such as Irish shares listed on the Enterprise Securities Market (an offshoot of the Irish Stock Exchange).
  • 2.40€ charge to buy 1,000€ worth of shares
• Lack of diversification
• Active reviews, research and monitoring required

This article shows how the assumptions I am using are the lowest possible in terms of fees for buying stocks. If you are using expensive brokers with annual account fees and high purchase charges this example would be even further exacerbated.

Comparison

Assumptions

• Investing 12,000€/year (1,000€/month) in ETFs
• Investing 11,851.20€/year (987.60€/month) in stocks due to there being 1% stamp duty and a 2.40€ commission for purchasing 1,000€ of shares on Degiro. This is MUCH higher on some other brokers as this article points out
• ETF performance 100% equities at 10% minus 0.19% management fees minus 1.9% inflation = 7.91% real rate of return
• Stock performance at 10% minus 1.9% inflation = 8.1% real rate of return
• Dividends for both 2% paid from year 1 (non-accumulating)
• Marginal net tax rate for stock dividends = 26% (gross income of 50,000€ for single person or 100,000€/couple)
• 20 year investment term
• Selling all assets at the end of the 20th year and paying all taxes due.
  • Although this is highly unlikely it is the only way I could compare the net effect of all taxes simply. This approach doesn’t take into account the stock gain exemption either which would also increase the stock output if selling little amounts each year of retirement.
  • I might look at a more comprehensive analysis including staged withdrawals at some point.

Outcome

So over 20 years, you end up with 70,291€ more in stocks than you would in ETFs with 28,000 less in taxes. This is a difference of 3,500€/year or the stocks earning a real rate of return of 0.31% more than the ETFs.

If you change any of the assumptions this comparison could swing in the other direction.

Even though stocks fare better, for now, I’m laying to rest my annoyance over not being able to get access to better tax rates for ETFs as I feel the pros of diversification and passive investing outweigh the potential additional gains of a stock portfolio.

I’m also hopeful that the hedge funds lobbying to bring the exit tax rates back in line with DIRT and CGT will be successful.

If that were to happen the above scenario would result in the ETF having 550,000€ as the end portfolio, paying 152,000€ in tax. And resulting in only 27,000€ less than the stock portfolio (or 1,350€ less per year).

What do you think? Have I missed something?

When I first came across FIRE, there was a lot of content focused on US and Canadian tax systems which on the surface seem much better in terms of investments and I scoured the internet to find similar ways to invest in Ireland as favourably to no avail. It seems that the Irish government has de-incentivized savings as they’d prefer people to stimulate the economy and spend instead. Every investment option is so punitively taxed that it almost seems worthless. I even considered moving my money back to Canada to invest it there but would have complicated matters from both a tax and foreign exchange perspective.

However… leave it to me to figure out a way to justify anything (just ask my husband), I think I found a way to put my complaints to rest based on 3 things:

1. Income tax rates are not as bad as they seem
2. Earning potential is higher in Ireland
3. Earning some interest is better than earning no interest

1. Income tax comparison

When I took a step back and compared my Canadian income to my Irish income I realised something interesting. The taxes aren’t that different.

Looking at my husband and I’s combined take home in Canada and dividing by the gross income as per our tax slips, the net effective tax rate was 29%. When I compared that to the following 12 months in Ireland, the net effective tax rate was 33%, so not much difference and we were earning more.

Income tax bands

One of the big differences that make the income taxes more comparable is that in Canada in 2019, an individual can only earn the equivalent of 8,238€ before you start paying taxes, but in Ireland you can earn 16,500€ before you start paying the 20% rate (this is the net effect of the 3,300€ and 1,650€ credits).

So while it seems that on the surface you are paying 52% income tax for anything over 35,300€ in actuality it looks something like this:

Looking at sample salaries starting with 20,000, which is just above minimum wage, here is what you actually pay in tax including PRSI and USC payments when you take into account your basic income credits and personal allowances, these figures do not include any other tax credits that may be applicable to you like medical or home carer credits which would further reduce the net tax rate:

Note that even at a salary of 100,000€ you are not at the 52% net tax rate that is so often quoted. In fact an individual would need to be earning over 2 million before their net taxes came to 52%.

2. Earning potential is higher

Now I know this won’t be the case for everyone but when my hubby and I were both working, we were taking home 60% more in Ireland than we were in Canada. This is due to higher paying contract roles and higher salaries in tech/pharmaceutical companies. Even when you take into account the additional 4% in income tax were we paying compared to Canada it still equates to a 56% increase in take home and I wouldn’t have considered our salaries to have been low when we were in Canada.

Just search the news for daily rate contract roles in Ireland and you will see how many more opportunities there are for those types of roles compared to Canada.

3. Earning some interest is better than earning no interest

In this case I’m going to look at the tax rates applied to Irish domiciled ETFs. There may be other options which have lower tax rates but based on my research, I’m happy to continue investing a large part of my portfolio in ETFs.

Even though taxes on dividends and gains for Irish domiciled ETFs is 41%, the fact remains that while the tax bill will be hard to swallow, it’s better than not investing at all.

For example: say you manage to save 100,000€ and that earns 8% over 10 years bringing in 115,000€ in growth. The tax man takes 41% (47,150€) which still leaves you with growth of 67,850€ and a portfolio worth 167,850€. Compare that to not investing and losing 1.9% to inflation each year, your 100,000€ would only be worth 82,545€.

So if you compare paying taxes on investments to not doing anything with your money, your opportunity cost would be 85,305€ or 8,530€/year.

I don’t know about you but I know which option I prefer.

Another silver lining to help swallow that tax pill, is that you are getting services and infrastructure for that money. It’s hard to stomach sometimes when you see it mismanaged but we need taxes to run a country and even if you are no longer earning traditional income, you will still be availing of the services provided by the state and so it’s only fair to contribute a portion of your passive income as well.

I’ll close by saying that, when you get your tax slip at the end of the year and you see how many thousands of euro have been taken in taxes, you don’t really think too much about it. It’s an unavoidable cost and part of working. The same outlook should apply to investing and although you should consult a professional to try and optimise your tax burden, hopefully looking at taxes in a different light will make it easier to start investing if you haven’t already.