The Canada Revenue Agency (CRA) has set the 2020 Tax-Free Savings Account (TFSA) limit at $6,000. Are you thinking of where to invest this money? The Toronto Stock Exchange is concentrated on natural resources and financial services stocks. There are some juicy tech stocks, but the NASDAQ and the New York Stock Exchange have many goods stocks that can make your TFSA portfolio well diversified. So, how to go about investing in U.S. stocks while still enjoying the tax benefits of the TFSA?
The TFSA tax advantage
The CRA created the TFSA in 2009 to encourage people above 18 living in Canada to invest a certain amount. It sets a contribution limit every year that can be carried forward. It levies income tax on this contribution but exempts all investment income (dividends, interests, and capital gains) from taxes.
Once you have put your money in TFSA, you can invest in stocks, ETFs, bonds, guaranteed investment certificates (GICs), and mutual funds trading on allowable exchanges. The stock and ETFs trading on the NASDAQ and NYSE also qualify. The CRA won’t tax you on your investment income from the U.S. stocks, but the U.S. Internal Revenue Service (IRS) will.
The IRS levies a 30% withholding tax on any U.S. stock dividend. Now, you can claim 50% of that deduction when you file your tax returns with the CRA, leaving you with an effective tax rate of 15% on U.S. dividends.
Investing in U.S. stocks through the TFSA
You can invest in U.S. stocks through the TFSA in a tax-effective way. It’s just that you need to adopt a proper strategy. The IRS charges a withholding tax on any U.S. stock dividend but does not tax capital gains. So, you can use your TFSA to invest in growth stocks like Advanced Micro Devices (NASDAQ:AMD). This stock has corrected 20% from its January high on the back of a chip supply shortage and a market pullback.
But AMD still has the technology lead over Intel. Once the supply shortage ends, AMD will return to its growth spree. It will continue powering the data centres and PCs of the future.
AMD is the sole chip supplier for Sony’s and Microsoft’s game consoles. It is the only strong competitor to Nvidia in the graphics card space, while Intel is catching up. It is well placed to tap the virtual and augmented reality market.
While the past performance is not a reflection of the future, the stock surged 88% last year and 377% a year before. If you invested $2,000 in AMD in 2018, you would now have $13,000 in your TFSA. An $11,000 tax-free investment income is not a bad deal. It has the potential to triple in the next five years.
Investing in U.S. dividend stocks
While that was about growth stocks, you need a diversified portfolio of growth and dividend stocks across different sectors and markets. Recently, Warren Buffett invested billions in Verizon, which offers a 4.3% dividend yield. If you want to enjoy the dividend of Verizon, you should buy it through the Registered Retirement Savings Plan (RRSP).
The IRS exempts dividend income earned through RRSP from taxes. But the CRA levies tax on any withdrawals from the RRSP. Instead of eyeing U.S. dividend stocks, Canada has a rich pool of dividend stocks you can invest in through the TFSA. The CRA will exempt dividend income from a Canadian stock earned through the TFSA.
A balanced TFSA portfolio
A good TSX dividend stock for your diversified TFSA portfolio is Enbridge (TSX:ENB)(NYSE:ENB). North America’s largest pipeline operator has a robust business model. It earns toll money from long-term contracts with utilities or transmitting oil and natural gas. The cash flow grows every year, as the company revises its rates and builds new pipelines. This model has helped it grow its dividends at an average annual rate of 10% in the last 26 years.
If Enbridge continues to grow its dividend at 6%, a $2,000 investment will increase your dividend income from $142 in 2021 to $306 in 2031. This money will be tax-free.
There is more to investing than just putting your money in the right stock. Investing the right amount in the right stock and in the right instrument can help you make the most of your investment income.