The Tax-Free Savings Account (TFSA) is one of the best investing tools available to Canadians. Any capital gains, interest, or dividends earned inside the account can grow completely tax free.
But there is one detail many investors overlook. If you hold U.S. stocks or ETFs inside a TFSA, the United States still withholds 15% of dividends. The IRS does not recognize the TFSA as a retirement account, so that tax cannot be avoided. It is taken off the dividend before the payment even reaches your brokerage account.
That does not mean you should never hold U.S. investments in a TFSA, but it does mean Canadian investments can sometimes be more efficient. For long-term TFSA investors who want simple, diversified exposure to Canadian income-producing assets, here are two ETFs that can work well as buy-and-hold positions.
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Vanguard FTSE Canadian High Dividend Yield Index ETF
The Vanguard FTSE Canadian High Dividend Yield Index ETF (TSX: VDY) is designed to track an index of Canadian companies with above-average dividend yields.
The portfolio holds roughly 50 large Canadian stocks, primarily from sectors known for strong dividend payments such as banks, pipelines, telecommunications, and utilities.
Because the Canadian market itself is concentrated in financials and energy, VDY naturally has heavy exposure to those sectors. Canadian banks alone make up a large share of the fund.
That concentration can create volatility at times, but it also reflects the reality of Canada’s dividend landscape. Many of the country’s most reliable dividend payers come from these industries.
The ETF currently offers a 3.6% dividend yield, which is paid monthly. Costs are also reasonable. The fund has a 0.22% management expense ratio, which is still low compared with most actively managed income funds.
For TFSA investors who want a straightforward way to collect Canadian dividends from established companies, VDY is a simple and widely used option.
Vanguard FTSE Canadian Capped REIT Index ETF
The second ETF to consider is the Vanguard FTSE Canadian Capped REIT Index ETF (TSX: VRE). This fund focuses on Canadian real estate investment trusts (REITs), which own income-producing properties.
REITs distribute a large portion of their income to investors, which can make them attractive for income-focused portfolios.
The structure of REIT distributions is also important. Much of the income they generate is classified as non-eligible income, meaning it does not receive the same dividend tax credit as traditional Canadian dividends.
That is where the TFSA becomes especially useful. Holding REITs inside a TFSA allows investors to avoid the taxes that would normally apply to those distributions in a taxable account.
VRE currently offers a 3% yield and provides exposure to a diversified group of Canadian REITs across retail, residential, industrial, and other property sectors. The fund has a 0.39% management expense ratio, which is higher than VDY but still reasonable.
