Can I hold U.S. stocks in a TFSA?”
Going by search engine data, it’s a question many Canadian investors ask themselves.
The literal answer to the question is straightforward: yes, you’re allowed to hold U.S. stocks in a TFSA.
However, there are some caveats here. If you hold U.S. stocks that pay dividends inside of a TFSA, you do sacrifice a small portion of the TFSA’s “tax-free” status by doing so. At the same time, U.S. dividend stocks are completely tax-free if held in an RRSP. So while you’re allowed to hold U.S. stocks in a TFSA, deciding whether to do so is a complex matter, especially if you consider holding the same stocks in an RRSP to be an opportunity cost.
In this article, I will explore three rules governing the tax treatment of U.S. stocks inside a TFSA, starting with the good news first.
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#1: Capital gains are still 100% tax-free!
The good news about holding U.S. stocks in a TFSA is that any capital gains you incur on them are 100% tax-free. No tax authority – Canadian or American – will tax you for selling a U.S. stock at a higher price than you bought it in a TFSA. If you held U.S. (or Canadian) stocks outside of a TFSA, you would pay taxes on capital gains. So, the TFSA “works” for holding U.S. stocks whose main draw is potential capital gains.
#2: You can’t skip the U.S. withholding tax
Where the TFSA doesn’t work so well is with U.S. stocks whose main draw is dividends. These have a 15% tax applied to the income. The tax isn’t a problem for stocks and funds with modest yields. However, it is a consideration when it comes to high payout ratio stocks with no growth potential, whose dividend is all the return you can reasonably expect. In this scenario, the U.S. withholding tax is a substantial cost.
As an alternative to high yield U.S. stocks, you might want to consider similar Canadian stocks like Enbridge Inc (TSX: ENB). As an eligible Canadian stock, ENB is fully tax-sheltered if held in a TFSA (unless you are over-contributing).
Enbridge stock currently has a 5.4% dividend yield, which is competitive with similar U.S. pipeline stocks. The company behind the stock is an indispensable part of North America’s energy infrastructure, shipping oil all over the States and supplying 75% of Ontario’s natural gas. The company also has strong financials, including a 7.3% net profit margin and a 10% return on equity. Overall, it’s one worth considering.
#3: You can’t get around withholding taxes with ETFs
Last but not least, and as a reminder that the withholding tax rule is a firm one:
You cannot escape the U.S. dividend withholding tax even by holding U.S. stocks through ETFs.
Investors sometimes come up with the idea of skipping the U.S. withholding tax by holding funds of U.S. stocks instead of holding such stocks directly. This seems like a nice idea at first, but the tax authorities and banks are way ahead of you here. Canadian funds of U.S. stocks are taxed at the fund level (i.e., before you even receive the dividend), while U.S. funds of U.S. stocks are taxed when dividends hit your account just like individual U.S. stocks. So, while ETFs are great instruments for diversifying your portfolio, they do not provide a magic pill for avoiding U.S. withholding taxes.
Foolish takeaway
So, there you have it: the TFSA account rules that pertain to holding U.S. stocks – or perhaps more accurately, the U.S. tax rules that pertain to TFSAs. As you can see, there aren’t really a whole lot of them. As long as you aren’t planning on going big on high yield U.S. dividend stocks, the rules won’t impede your investments all that much. If you hold non-dividend U.S. stocks, there is nothing to be concerned about at all!
