International Dividend Growth For Your IRA Or 401(k)

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Includes: BT, IMO, INFY, TD, UL, UN
by: Bottom Fisher Ideas

Summary

International diversification is an important consideration for all investors.

Dividend tax withholding makes international dividend growth investing challenging, especially in an IRA or 401(k).

Canada, India, and the United Kingdom all offer dividend growth stocks with no tax withholding, suitable for retirement accounts.

Investment Thesis

International diversification is important, but can be challenging for dividend growth investors using an IRA or 401(k). Three countries, Canada, India and the UK, provide dividend growth investment opportunities without dividend withholding taxes. By investing in some of these opportunities, you can add international diversification without the accompanying tax penalties.

International Investing

International diversification is an important consideration in any investor's portfolio, although the subject is not without its controversy. Two of the world's investing giants, Warren Buffett and Jack Bogle, have frequently advocated for exclusively domestic investing. Their primary arguments are about American exceptionalism, the international exposure of many US companies, and comfort level.

This happens to be one of the few subjects that most investors and academics disagree with these icons about. Notably, Vanguard's own advice conflicts with the views of its founder:

Vanguard research has shown that while holding some portion of a diversified equity portfolio in international equities has helped to temper the volatility of U.S. equities, the majority of the benefit was achieved as the international allocation increased from 0% to 20% of total equity exposure, with incremental additional benefit up to 50%.

I happen to agree with Vanguard and most investment professionals, and I keep between a 20% and 50% of my equity allocation in international stocks.

Dividend Withholding Tax

One of the pitfalls of international dividend growth investing for US investors is the dividend withholding tax. Most countries withhold a portion of the dividends that they pay to residents of other countries. This can create a headache in a taxable brokerage account, but by filing the right paperwork with the IRS, you can get credit for those foreign taxes on your tax return. The real danger lies in tax-advantaged accounts like a traditional IRA or a 401(k). Most countries withhold a portion of the dividend even if you own the stock in a retirement account and there is no means to get that money back.

There are dozens of countries that don't withhold taxes from dividends for US residents, and one that makes a special exception for holdings in retirement accounts. Of those countries, only three have stocks with at least a 5 year history of dividend growth. The United Kingdom and India each withhold nothing from dividends, and due to a tax treaty with the US, Canada withholds nothing from dividends of stocks held in IRAs and 401(k)s. (Canada will still withhold if the security is held in a taxable brokerage account.)

The list below is not comprehensive, as I've excluded companies with especially low dividend yields (less than 1.50%). And while there is only one stock from India that qualifies, Canada and the United Kingdom provide a wealth of options for the dividend growth investor.

Country Ticker Company Name Sector Dividend
Canada
BCE BCE Telecom 4.72%
BMO Bank of Montreal Financial 3.82%
BNS Bank of Nova Scotia Financial 3.85%
CM Canadian Imperial Bank of Commerce Financial 4.71%
CNI Canadian National Railway Industrial 1.54%
CNQ Canadian Natural Resources Energy 2.78%
ENB Enbridge Energy 4.67%
IMO Imperial Oil Energy 1.68%
MGA Magna International Consumer Discretionary 2.42%
PBA Pembina Pipeline Corp Energy 4.60%
RBA Ritchie Bros Auctioneers Industrial 2.17%
RY Royal Bank of Canada Financial 3.64%
SJR Shaw Communications Consumer Discretionary 4.11%
SU Suncor Energy Energy 3.09%
TD Toronto-Dominion Bank Financial 3.64%
TU Telus Corp Telecom 4.38%
TRP Transcanada Corp Energy 3.90%
India
INFY Infosys Technology 2.25%
United Kingdom
BP BP Energy 6.64%
BT BT Group Telecom 4.76%
BTI British American Tobacco Consumer Staples 3.10%
DEO Diageo Consumer Staples 2.52%
HSBC HSBC Holdings Financial 5.77%
NGG National Grid Utilities 5.75%
PUK Prudential Financial 2.47%
RELX RELX Industrial 2.16%
SNN Smith & Nephew Health Care 1.91%
UL Unilever Consumer Staples 2.58%
VOD Vodafone Group Telecom 5.26%
WPPGY WPP Consumer Discretionary 3.11%

Portfolio Choices

If I intended to hold 10-15 dividend growth stocks in my retirement account, I would aim for 3-6 international stocks. For maximum country and sector diversification, I might start with Infosys Ltd ADR (NASDAQ:INFY), and then include one or two Canadian stocks and one or two UK stocks.

I personally invest in Imperial Oil Ltd (NYSEMKT:IMO) and BT Group (NYSE:BT) for my Canada and UK exposure due to their attractive valuations. I might consider adding Toronto-Dominion Bank (NYSE:TD) and Unilever PLC ADR (NYSE:UL). Unilever PLC is a particularly interesting company as it is a Dutch-British multinational. The beauty of Unilever is that it provides slightly broader exposure to Europe than with other UK stocks, while still avoiding the dividend withholding tax. But if you choose to invest in Unilever in a tax-advantaged account, make sure you invest in Unilever PLC and not Unilever NV (NYSE:UN). Unilever NV shares are issued from the Netherlands and do withhold dividend taxes.

So with our sample allocation to Infosys, Imperial Oil, BT Group, TD Bank and Unilever PLC, we have exposure to three or four different countries (India, Canada, UK, and the Netherlands) in five different sectors (financials, tech, energy, telecom, and consumer staples).

This is just one example, obviously. There are many fine dividend growth companies on the list to choose from to add international diversification to your portfolio.

Conclusion

Despite the leanings of some prominent investors, research indicates that there are benefits to holding 20% to 50% of your equity allocation in international stocks. Dividend tax withholding can eat away at your returns if you aren't careful, but dividend growth stocks from Canada, India, and the UK can allow you to achieve international diversification in your IRA or 401(k) without paying unnecessary taxes.

Disclosure: I am/we are long IMO, BT.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.