The Tax-Free Savings Account (TFSA) is easily one of the most powerful investing tools Canadians have. The fact that you can contribute thousands of dollars each year and invest that money in Canadian stocks for the long haul without paying any taxes on it is a massive advantage.
Taxes are by far the biggest drag on your portfolio when it comes to compounding. That’s why the TFSA is such a powerful tool for Canadians. And you can even buy and hold U.S. stocks inside your TFSA too.
However, while you can buy and hold U.S. stocks in your TFSA, there’s a bit of fine print that many investors either overlook or don’t fully understand, which makes the advantages less optimal than they are with Canadian stocks.
Source: Getty Images
What to know about owning U.S. stocks in your TFSA
So, while any capital gains you earn on U.S. stocks inside your TFSA are still completely tax-free in Canada, the difference comes with dividends.
The United States imposes a 15% withholding tax on dividends paid to Canadian investors. So, although if you hold U.S. stocks in a non-registered account, typically that 15% can often be claimed as a foreign tax credit on your Canadian tax return.
Inside your TFSA, however, you can’t recover that withholding tax since the TFSA is considered a tax-free account by Canada but not recognized as a retirement account by the U.S. For example, if a U.S. stock pays a $100 dividend, you’ll only receive $85 inside your TFSA after the withholding tax is deducted.
That doesn’t make U.S. stocks a bad choice for a TFSA. It just means that dividend investors need to understand that the yield you see quoted is not the exact yield you’ll receive after the withholding tax.
This is one of the main reasons some investors prefer to hold U.S. dividend stocks inside a Registered Retirement Savings Plan (RRSP) instead. The RRSP is recognized as a retirement account under the Canada-U.S. tax treaty, which means U.S. dividends paid inside an RRSP are not subject to the 15% withholding tax.
The good news for investors
The good news for investors is that there are a ton of high-quality U.S. stocks that don’t pay a dividend or offer yields of less than 1%. High-potential, early-stage growth stocks don’t typically offer much of a dividend, if at all.
For example, high-quality growth stocks like Alphabet, Amazon, Nvidia, Apple, and Meta pay no dividend at all or offer yields of less than 0.5%, making these the types of U.S. stocks that make the most sense to own in your TFSA.
If you are a dividend investor, there are a ton of high-quality Canadian dividend stocks to consider, especially ones with operations in the States, or that trade on both exchanges.
For example, Enbridge is one of the best and most popular dividend stocks among Canadian investors, which not only trades in both Canada and the U.S. but also has operations across both countries, offering Canadians exposure to the U.S. economy through a Canadian stock.
So, if you’re looking to build the optimal TFSA portfolio with both high-quality Canadian and U.S. stocks, you’ll want to keep the fine print on U.S. dividend stocks in the back of your mind.
