This post will compare a 20-year investment into stocks and ETFs in Ireland. I will show how ETFs really compare to stocks.
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
| ETF | Stocks | |
| Total invested | 240,000 | 237,024 |
| Total gains | 361,251 | 399,265 |
| Total tax on gains | 148,113 | 131,758 |
| Total dividends | 91,340 | 98,584 |
| Total tax on dividends | 37,450 | 25,632 |
| Total taxes | 185,562 | 157,389 |
| Total portfolio after 20 years | 507,029 | 577,484 |
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?
Did you not include dividends in the stock portfolio by any chance?
I might have missed something but ignoring dividends I got these figures for the stock portfolio
Total Invested = €237024
Total Gains = €355774
Total Tax on gains = €117405
Final Portfolio Worth = €475392
Yup you caught it. I forgot to drag the formula down for the dividends. Stocks win out by 70k, I’ll update the post. Darn! lol
It’s great to have articles like this from an Irish perspective btw… I’ve learned a lot from them so far, thank you!
Ah great, and thanks for catching my hiccup 🙂 great to have like-minded readers to keep you on your toes 🙂 I’ve updated the article now.
Absolutely great to see articles like this from an Irish perspective. I can’t imagine any reduction in tax any time soon due to the deficit in the public finances the government has to run due to the Covid-19 crisis. Maybe in 8years!!!
Thanks 🙂 – And true, maybe it’s wishful thinking but I am ever the optimist! 8 years suits me fine as I don’t plan to be withdrawing until then anyway.
Hi Meagan
Thanks for updating, and i’ve very much enjoyed reading your site :).
There could be a way to bridge the gap between the ETF and Stock projections.
For the ETF – assuming the ETF is accumulating with dividends automatically reinvested will increase the projection as exit tax on those dividends won’t occur until year 8.
For the Stocks – as we are in the Accumulation Phase of our FIRE journey then (assuming 50,000 salary income) dividends will be taxed at 40%+4%+4.5% = 49.5% because the dividend income will be on top of our salary income. When we reach the withdrawal phase of our FIRE journey then the net tax will be circa 26% because all our income is from dividends because we are no longer receiving a salary income.
Hi Emmet, Thanks for that, yes I must look at the accumulating dividends for ETFs as I believe that is not an option for stocks? In terms of salary that’s an interesting point, though the dividends are so low in the first number of years that it wouldn’t really push your net income tax rate much higher than the 26.4%. Even in the 20th year, the dividends are 12,945€ bringing your gross income to 63,000€ on which you would pay about 19,000€ in tax (31% net). Unless I’m missing something?
Just want to say that I find the information you provide on this blob to be very useful and practical and most importantly very applicable for an Irish person. Thank you very much for your continued inputs and effort!
on this vlog* lol
Thanks very much 🙂
That is with trading irish stocks? if you trade american stocks, your tax rate would be much higher if I’m not wrong? hence you’d get a better return with EFTs.
I don’t think US stocks are taxed higher. From what I can see, Irish shares have a 20% withholding tax applied to dividends when they are paid out. This acts as a credit for when you file your taxes, you will only pay the difference owed on top of the 20% already withheld. US stocks have a 30% withholding tax unless you file a W8-BEN form with your broker which allows you to only have 15% withheld. This also acts as a credit to reduce the taxes owed at the end of the year. Essentially the government are taking insurances that they are paid taxes whether you file or not but doesn’t ultimately affect your returns as you will pay the same amount of tax in the end for both.
Also from what I can tell capital gains taxes are the same for all shares regardless of location.
But readers, please correct me if I’m wrong
Hi. What about the fact that no stamp duty is required on US shares? That gives you an additional 1%. I know there’s locations which do not require stamp duty but just saying US as it’s got the major markets. Or is that % offset by currency ?
Interesting! I didn’t piece that together but see now after a bit of digging that you can buy US shares on Degiro and no stamp duty applies. In terms of currency exchange risk yes I haven’t quite figured how to model that into analysis yet but just looking at the last 5 years fluctuations between EUR and USD the difference between highest and lowest is 16%. So if your entire portfolio was in USD and you needed 35k to live on in retirement in 2016 you would have had to withdraw 36k compared to 44k in 2018 – a difference of 7k. Not sure if that’s the right way to look at it and I’m surprised the fluctuation is that big. It’s double that of CAD to EUR which was only 8% difference for the same time frame.
Hi Meagan,
I’m still in the learning phase :). I’d never heard of FIRE or an EFT before the lockdown. I don’t think you can have an ‘accumulating stocks & dividend’ portfolio; only for ETFs. As for the dividend income in the last year; using Oisin’s final value of 475,392 (from first comment above) will the dividend in the final year = 2% * 475,392 = 9,507?
This is the way i’ve been looking at it:
If i earn 50,000 p.a and i’m offered a promotion of 9,507, i need to consider that i’m already earning 50,000 before i determine whether this increase is worth the additional responsibility. This is because i’ll pay tax on the additional amount at 40% + 4% + 4.5% = 49.5%. Therefore (assuming no increase in pension contribution) i’ll see only 4,801 of this amount.
Similarly if i’m earning 50,000 and i’m considering taking a part time job at the weekend, I need to consider that i’m already earning 50,000 before i determine whether this increase in take-home pay vs lost free time is worth it.
I’m trying to apply a similar concept to determining the best approach for the accumulation phase of the FI cycle.
i know that if i have an accumulating ETF, and i’m earning 50,000, then the exit tax on dividends will be 41% (in fact my income of 50,000 is irrelevant). And I’ll get the growth on the dividends too before 41% is applied at 8 years/withdrawal.
However if i use stocks for the accumulation phase of the FIRE journey, and i’m earning 50,000, then i know that the dividends will be taxed at 49.5% (similar to my pay increase or part time job examples above).
Maybe my explanation was a bit long winded and better explained by applying this to the 53,000 income you mentioned i.e. 50,000 salary + 3,000 dividend.
The tax on this is net 27.34% as you said. Using the 26% net tax that you mentioned in your article for a 50,000 salary we can apply the following weighted sum:
(50,000*26% + 3,000*49.5%)/(53,000) = 27.33%
i.e. the net is 27.33% but the tax on the dividend proportion is 49.5%
I’m of two minds on this and not sure the right way to look at it. For example, say your dividends are paid out quarterly. In quarter 1, you’d pay 4-5% tax as you’re under your base amount, in Q2 you’d pay the 20% +PRSI+USC, same for Q3 and then Q4 you’d pay the 52% or whatever. The net effect at the end of the year would be that you only paid X amount on your entire income.
I get what you’re saying but I’m not sure which is right.
In terms of your analysing promotions/new jobs, I agree it’s important to look at the net effect on your take-home vs the added responsibilities and time etc. I do the same. But I do look at the net effect overall rather than just the taxes on the pay increase. ie: In a job paying 50k, going for a job paying 20k more – net take-home difference = 10,300€ which is essentially the same outcome as to how you’re looking at it (50% of the 20k difference). So maybe much of a muchness 🙂
Re: dividends in year 20, I updated my original comment as I had included the tax amount and not the gross amount which was almost 13,000€.
This is all making me think I need to educate myself more.
I’ll invest in accumulating ETFs for the foreseeable future for ease of investment. And build my knowledge over time.
For accumulating ETFs that are domiciled in Ireland; does anyone know if withholding tax is applied to dividends before they are reinvested? i.e. is the full dividend reinvested or is it the dividend amount less any withholding tax (be it from the Irish government or from the country where the stock is domiciled)
i think you answered my question in an earlier article:
https://mrsmoneyhacker.com/my-irish-etf-portfolio/
I’m definitely still learning myself. Things are always changing and there are always different ways to look at things. In terms of ETFs, as far as I can see there are no withholding taxes applied. From what I can tell withholding taxes only apply to individual stocks and bonds. I don’t have accumulating funds yet so can’t say for certain how those work either but once I do switch over I’ll update the blog 🙂
I wouldnt say you missed it as you mentioned it but the inability to offset losses of different years/investments is quite risky. If the market crashes in the last year or two of your investment horizon, any losses suffered cant be offset against your earlier gains. This adds a large amount of risk even though your returns are similar.
Add to that the fact that if you have diversified across multiple ETFs, you cannot offset losses of a poorly performing index.
It really is an illogical rule which encourages investors to take on more risk by not diversifying through etfs.
Why can’t you buy US ETFs? Did you know that 79.5% of all listed bonds, stocks and ETFs in the world are USD-denominated? So it is hard to avoid US bonds, stocks and ETFs, if you want a diversified portfolio? I have an Interactive Brokers account and they charge me 1-2bps per transaction. Also the bid-offer spreads are lower on the more liquid investments. The downside is that they charge me 1.75%pa to borrow USD and they also charge me for holding EUR deposits.
Hi Frank, Thanks for the comment. You used to be able to buy US domiciled ETFs in Europe but as of Jan 2018 the EU brought in a rule where every product would require a key information document in order to continue selling to retail investors in Europe. To date, the fund providers have said they will not be putting these in place for retail investors. These US domiciled ETFs were taxed more favourably than Irish and EU ones but are only available to purchase through some fund managers. Domicile and underlying currency are two different things. Agree that the underlying currency of the vast majority of ETFs are in USD but the domicile of where they are registered and how taxes are treated are based on domicile and not currency if that makes sense?
Great article Meagan. Really good to see something like this from an Irish point of view as there isn’t too much content like this out there. Have you ever thought of doing some more content like this on YouTube? Lots of North American’s are doing this and it can be really informative so would be great to have a Irish version.
Hey! Thanks – yes I have considered branching out into YouTube but I’m already spread thin in terms of writing blog posts, researching, analysing and providing consultations so adding video editing and posting there too would potentially water down all delivery vehicles rather than complimenting them. Maybe as I near FI, or as baby gets a little more independent and I have a bit more free time (wishing thinking?), I will branch out but for now I’m sticking to writing. Thanks for the vote of confidence!
Just discovered your blog, very timely because i can relate in many ways to your experiences. As a US citizen who recently moved to IE and wants to start investing in the latter, your posts are a wealth of info on basically anything about finances on the eye of an expat. Thank you for all your writing. It definitely saves me a lot of research.
Aw glad to be of help. I know how daunting it all can be, I still can’t believe I am learning something new every week despite thousands of hours of reading into the topic! Only too glad to share.
Hi Meagan,
Great blog, really useful information, thanks for sharing.
Would you not have access to US-domiciled ETFs through a Canadian brokerage? The reason I ask is that I’ll be moving to the US shortly for one year and will then be returning to Ireland. I was hoping to access US-domiciled ETFs once I moved, or is there something I’ve overlooked?
Thanks
HI Steve, Yup I do have access to US-domiciled ETFs through Canadian brokerage but I think the cost of transferring money to and from Canada (currency exchange fluctuations/risk+currency exchange and transfer fees both on entry and exit) + currency exchange risk on growth etc would all negate any benefit not to mention the tax reporting issues/headache. Even though the tax treatment is slightly better I’m opting for simplicity over shaving a few months off my FI date.
One reader commented that US shares do not have the 1% stamp duty, I didn’t piece that together but see now after a bit of digging that you can buy US shares on Degiro and no stamp duty applies but as the reader also suggested this may be wiped out by currency exchange risk. While I haven’t quite figured how to model that into analysis yet, just looking at the last 5 years fluctuations between EUR and USD the difference between highest and lowest is 16%. So if your entire portfolio was in USD and you needed 35k to live on in retirement in 2016 you would have had to withdraw 36k compared to 44k in 2018 – a difference of 7k. Not sure if that’s the right way to look at it and I’m surprised the fluctuation is that big. It’s double that of CAD to EUR which was only 8% difference for the same time frame.
thank you Meagen!