While ETFs trade on an exchange like stocks, there are some differences when it comes to fees. Largely, that comes in the form of management expenses, which apply to ETFs.
Both passively and actively managed ETFs incur management expenses. This is typically expressed as a management expense ratio, or MER. Passively managed funds generally have lower fees than actively managed funds.
Management expense ratio (MER)
MER, also known as the expense ratio, is the annual fee that all funds charge shareholders for holding the fund. Expressed as a percentage of assets under management (AUM), it captures the management fee, operating expenses and taxes incurred by a fund on an annual basis. Operating expenses can cover items such as fund valuation costs, audit and legal fees and costs related to prospectuses and annual reports. The MER doesn't include sales commissions you may pay, or the fund's trading costs. A fund's prospectus will offer more information.
Management fee
This is an annual fee payable by the fund to the manager of the fund for acting as its trustee and manager. This fee forms the largest portion of the MER. It represents the costs shareholders paid for the fund's management and distribution over the past fiscal year, including custodian and valuation agents, registrar and transfer agents, and any other service providers retained by the manager.
Trading commissions
Since ETFs trade like stocks on an exchange, they are subject to commission when bought and sold. While most ETFs have the same commission as stocks, at RBC Direct investing there are over 50 ETFs that are eligible for commission free trading. To learn more about these ETFs, click here.
Taxes
If you realize a capital gain when you sell your ETF, or if the ETF distributes capital gains at year end, you will have received taxable capital gains that must be included in your total taxable income. If you are receiving dividends1, interest, or other ordinary income from your ETF, that would also be considered taxable income to report on your income tax return.
Although a TFSA is a registered account providing the account holder with tax free income and capital gains for Canadian income tax purposes, a TFSA is not exempt from foreign withholding taxes. This is in contrast to RRSPs which may be exempt from foreign withholding taxes if the tax treaty between Canada and the foreign country allows the withholding tax exemption. Therefore, foreign withholding taxes may apply to distributions from foreign securities, including ETFs, stocks and bonds when held in a TFSA.
The information provided in this article is for general purposes only and does not constitute personal financial advice. Please consult with your own professional advisor to discuss your specific financial and tax needs.
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1Dividends earned pursuant to DRIP may be subject to requirements imposed by the Income Tax Act (Canada). It is your responsibility to ensure that any associated tax requirements or obligations are satisfied.
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