CRA: Making This TFSA Mistake Will Result in More Taxes

Holding dividend-paying foreign stocks in your TFSA isn’t the best strategy as you will have to pay tax on the dividends you receive.


Image source: Getty Images

While there are many great stocks here in Canada, you may want to diversify your portfolio by buying stocks from foreign companies. It’s fine to include U.S. and international stocks in your Tax-Free Savings Account (TFSA) portfolio, as there is no limit on the amount of foreign content that you are allowed.

But there are some things to keep in mind. If you want to buy foreign stocks that pay dividends, you should know that foreign dividends are treated differently in a TFSA than Canadian dividends or interest income.

Foreign dividends are taxable in a TFSA

You may not want to hold investments producing foreign income in your TFSA due to the tax consequences.

On withdrawal, Canadian dividends and interest are specifically tax-exempt in a TFSA when earned. Non-Canadian dividends, including those paid by U.S. blue-chip stocks, are subject to non-resident withholding tax (NRT) in a TFSA.

The IRS levies a 15% withholding tax on dividends paid to Canadian resident investors. Whether you own U.S. stocks directly in your TFSA or have a Canadian mutual fund or exchange-traded fund (ETF) that holds U.S. stocks, the result is the same.

You can’t avoid the 15% withholding tax. To make matters worse, you also can’t access the foreign income tax credit, which you can claim on U.S. stocks bought in a non-registered account to offset withholding tax deducted. There’s no way to avoid these taxes in a TFSA. Like any tax, it eats into the amount you actually earn.

For example, the annual dividend paid on 100 shares of McDonald’s is currently US$500, but if you hold these shares in your TFSA, you would only receive US$425 in dividends. The difference of US$75 is lost in withholding tax. On the other hand, if you buy Canadian dividend stocks in your TFSA, you can keep the full amount.

For example, if you buy 100 shares of Toronto-Dominion Bank, you’ll receive the full annual $316 dividend in your account.

You should keep dividend-paying foreign stocks in your RRSP

Although there is an exemption for U.S. dividends paid into an RRSP or RRIF through the tax treaty between Canada and the United States, there is currently no such exemption for the TFSA.

The IRS doesn’t withhold tax at source on U.S. dividends earned in an RRSP account. They respect the non-taxable status of investment income in an RRSP.

The IRS doesn’t care that TFSAs are tax-free. Despite the similarity to U.S. Roth IRAs, the IRS doesn’t consider the TFSA as a registered plan. It’s therefore better to hold U.S. stocks inside an RRSP.

If you have an RRSP and a TFSA, it’s preferable that your TFSA is mainly or exclusively invested in Canadian stocks so your dividends are all tax-exempt.

If you want to have some foreign exposure in your TFSA, you could buy foreign stocks that don’t pay dividends. You should be careful when choosing stocks that don’t pay dividends, as these stocks tend to be higher-risk growth stocks. In a TFSA, capital losses can’t be used to offset capital gains.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Stephanie Bedard-Chateauneuf has no position in any of the stocks mentioned.

More on Dividend Stocks

grow dividends
Dividend Stocks

3 Canadian Stocks With a Real Chance of Doubling Your TFSA’s Value

Three outperforming Canadian stocks can help TFSA investors double their account balances.

Read more »

Hand writing Time for Action concept with red marker on transparent wipe board.
Dividend Stocks

3 No-Brainer Stocks I’d Buy Right Now Without Hesitation

At any given time, the market may have certain stocks that offer a powerful combination of reliability, potential, valuation, etc.,…

Read more »

money cash dividends
Dividend Stocks

This 8.39% Dividend Stock Can Pay $100 Cash Every Month

Consider investing in this monthly dividend stock at current levels to lock in high-yielding monthly distributions to create a good…

Read more »

TFSA (Tax free savings account) acronym on wooden cubes on the background of stacks of coins
Dividend Stocks

Here’s the Average TFSA Balance in 2024

The Bank of Montreal (TSX:BMO) says that the average TFSA balance is $41,510, far below the maximum.

Read more »

A glass jar resting on its side with Canadian banknotes and change inside.
Dividend Stocks

Investors: Here’s How to Make $1,000 Each Month in Retirement

Here's how you can easily make $1,000 in monthly passive income in retirement in Canada, without taking on too much…

Read more »

man touches brain to show a good idea
Dividend Stocks

3 No-Brainer TSX Stocks I’d Buy Right Now Without Hesitation

Three TSX stocks that continue to overcome massive headwinds and beat the market are no-brainer buys right now.

Read more »

calculate and analyze stock
Dividend Stocks

TFSA Investors: 2 Top TSX Dividend Stocks to Buy on a Dip and Hold Forever

These top TSX dividend stocks now offer attractive yields and big potential capital gains.

Read more »

grow money, wealth build
Dividend Stocks

1 Dividend Stock to Buy for Growth and Stay for a 5.5% Yield

This dividend stock has been rising higher, but more could certainly be on the way. Now is the time to…

Read more »