The TFSA is one of the best wealth-building tools available to Canadians. And while there’s no shortage of great investments in Canada to add to that account, investors looking to diversify should consider owning U.S. stocks in your TFSA.
One of the main reasons for that is that the U.S. market is the largest in the world. It provides exposure to global leaders across a variety of different sectors. That includes growth-focused tech stocks, leading healthcare picks, consumer goods titans, and other sectors less available on the TSX.
Before investors buy those U.S. stocks in their TFSA, there is one important consideration to understand.
The TFSA allows all capital gains, interest, and dividends to compound tax-free. That same shelter doesn’t apply to dividends paid by U.S. companies. Those investments are subject to a 15% withholding tax before those dividends reach the account.
That doesn’t mean investors should avoid U.S. stocks. Instead, it just means investors should be aware of the type of U.S. stock they are investing in.
Let’s look at a few examples to consider for any TFSA.
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Johnson & Johnson is a quality dividend payer with a trade-off
Johnson & Johnson (NYSE: JNJ) is one of the best-known and respected businesses on the planet. It’s also the type of business Canadian investors may want to own for decades.
Johnson & Johnson operates a diversified portfolio that consists of pharmaceutical and medical technology businesses. Its products are essential and purchased by consumers globally regardless of how the economy is faring.
The company is also well-known as one of the best dividend payers on the market. Specifically, it’s a Dividend King with decades of annual increases. That makes it appealing for investors seeking a mix of income and defensive appeal.
The trade-off for Canadian investors looking to add U.S. stocks to their TFSA is that a portion of every Johnson & Johnson dividend paid will be withheld. For example, a $100 dividend payment would result in $85 reaching the account after the 15% withholding tax.
While Johnson & Johnson is a great long-term investment, its dividend from within a TFSA isn’t as tax-efficient as some other Canadian dividend payers.
Nvidia may be a better TFSA fit for growth investors
Another popular option for investors looking to add U.S. stocks in your TFSA is Nvidia (NASDAQ: NVDA). The technology titan is the largest company on the planet by market cap. As of the time of writing, it has returned an absolutely insane 850% over the past five years.
While Nvidia does pay a dividend, its payout of $0.25 per share is tiny. That’s especially true when considering the immense growth potential of the stock. Investors own the stock for its growth potential, which includes its role in artificial intelligence, data centres, and accelerated computing.
With such a small amount of dividend income to withhold from, the 15% tax becomes far less of an issue. Meanwhile, any capital gains generated by a successful long-term investment can grow and eventually be withdrawn tax-free from the TFSA.
Canadian National Railway avoids the withholding-tax issue
If you’re an investor looking to add U.S. stocks to your TFSA, another option might be to consider a Canadian company that operates in the U.S. Canadian National Railway (TSX: CNR) is a great example of that.
Canadian National is a Canadian company with a rail network that expands deep into the U.S. market, providing exposure to North American trade and industrial activity.
Like Johnson & Johnson, Canadian National pays a dividend and also rewards investors through both income and long-term capital appreciation. But unlike Johnson & Johnson, the dividend is not subject to U.S. withholding tax for Canadian investors holding it in a TFSA.
This makes Canadian National a far more efficient option for TFSA investors seeking to prioritize income and minimize tax withholdings.
U.S. stocks in your TFSA: The bottom line
U.S. stocks can still be excellent TFSA investments. Recall that the withholding tax applies only to dividends, not to capital gains. This shouldn’t prevent investors from owning a stock they believe can deliver long-term returns.
For income-focused investors, prioritizing Canadian-owned stocks such as Canadian National might be the efficient route to generate tax-free income inside a TFSA.
Alternatively, investors may want to consider holding U.S. dividend stocks in an RRSP. Qualifying U.S. dividends are generally exempt from withholding tax in that account.
For growth investors, companies such as Nvidia can provide significant long-term growth.
