The TFSA is one of the best wealth-building options for Canadian investors. It allows for most dividends and growth in the account to remain tax-free. However, holding U.S. stocks in a TFSA can still expose dividend payments to foreign withholding tax.
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What holding U.S. stocks in a TFSA actually costs
For Canadian residents, U.S. dividends are generally subject to a 15% withholding tax within a TFSA. And that’s an amount which can’t be recovered from a Canadian foreign tax credit. By contrast, dividends from U.S. stocks held directly in an RRSP are exempt from U.S. withholding tax.
Fortunately, that 15% tax applies only to the dividend payment. Let’s look at two examples.
First up is Nvidia (NASDAQ: NVDA). A $10,000 position in the tech giant will generate about $47 in annual dividends given the 0.47% dividend yield as of the time of writing. The tax on that investment works out to about $7.05.
Fortunately, in this case, an investor considering Nvidia is unlikely to be thinking about a dividend. Capital appreciation is the more likely objective.
Secondly, let’s look now at Johnson & Johnson (NYSE: JNJ). The company offers a 2% yield. Given that same $10,000 investment, that works out to $203 in annual dividends. The withholding on that investment in this case comes in at $30.45.
In both cases, that deduction hits the dividend payout before it reaches the TFSA account.
Canadian National offers a different route to growth
Canadian investments offer alternatives to holding U.S. stocks in a TFSA. One such option is Canadian National Railway (TSX: CNR).
Canadian National operates one of the largest railway networks on the continent. That vast network spans across Canada and down the U.S. Midwest to the Gulf Coast. In doing so, Canadian National offers a rare connection to three coastlines. This gives Canadian National a key defensive role in moving goods across the North American economy.
Those goods can be anything from automotive components and chemicals to crude oil, wheat and precious metals.
That network is also incredibly difficult to replicate. A competitor attempting to build a comparable network would need decades to build and tens of billions in capital.
As a result, the defensive appeal of the railway, coupled with the sheer importance of the goods it hauls, makes it a must-have investment.
In terms of income, Canadian National offers a 2.1% dividend yield. The company also offers three decades of consecutive annual increases. This makes it a viable alternative to Johnson & Johnson’s long-standing dividend and respectable yield.
That being said, for investors who already hold U.S. stocks in a TFSA, Canadian National doesn’t offer Nvidia’s direct exposure to AI or its growth potential.
Fortis brings consistency and U.S. business exposure
Another option for investors seeking an alternative to Johnson & Johnson’s consistency is Fortis (TSX: FTS). Fortis is one of the largest utility stocks in North America, operating electric and gas utilities across Canada, the U.S. and the Caribbean.
Electricity and natural gas service is a necessity that homes and businesses need. Demand for those services tends to hold up during economic downturns.
The regulated nature of a utility means that Fortis can reliably predict its revenue stream. By extension, it also means that Fortis can continue to invest in growth initiatives and increase its quarterly dividend.
As of the time of writing, Fortis offers a 3.2% yield. The company has also raised that dividend annually for 52 consecutive years.
Choose the investment before chasing tax savings
Canadian alternatives can make sense for new TFSA contributions, particularly when dividend income is a priority.
Investors who already hold U.S. stocks in a TFSA should note that saving a few dollars in dividend tax doesn’t automatically justify giving up a company’s growth prospects or sector diversification.
For my TFSA, Canadian National and Fortis offer plenty of appeal beyond their tax treatment.
