A Tax-Free Savings Account (TFSA) is a great place to hold your investments. The Canada Revenue Agency (CRA) won’t tax any income you earn within the account, whether it’s from mutual funds, bonds, REITs, or, yes, even U.S. stocks.
As long as the U.S. stock you want to buy trades on a designated exchange, you can hold it in your TFSA. The CRA won’t tax any capital gains or dividends earned on your U.S. investments, but the IRS will levy a tax on dividends, even if the dividend stock is in your TFSA.
Below we’ll look closely at buying U.S. stocks in your TFSA, the tax liabilities this comes with, and if it’s the right choice for your investing strategy.
Can you buy U.S. stocks in a TFSA?
Yes, you can buy U.S. stocks in a Tax-Free Savings Account (TFSA).
There’s only one requirement to hold U.S. stocks within a TFSA: you must pick stocks that are trading on designated exchanges. These include all the major U.S. stock exchanges, such as the NASDAQ and NYSE, plus some extras.(1) The list includes these 12 U.S. exchanges:
- BATS Exchange
- NASDAQ BX
- Chicago Board of Options
- Chicago Board of Trade
- Chicago Stock Exchange
- Investors Exchange LLC
- National Association of Securities Dealers Automated Quotation System (NASDAQ)
- National Stock Exchange
- New York Stock Exchange (NYSE)
- NYSE Arca
- NYSE MKT
- Nasdaq PHLX
U.S. stocks aren’t the only foreign stocks you can hold in a TFSA. In fact, the CRA allows you to buy and hold foreign stocks from 30 different countries, including Australia, Japan, Germany, the United Kingdom, Mexico, and South Africa, among others.
Can you trade in USD in a TFSA?
Yes, many banks allow you to trade in USD within a TFSA. Whether or not you can, however, will depend entirely on your TFSA provider.
Some TFSA providers will allow you to exchange your loonies for U.S. dollars upfront, then buy U.S. stocks within your account. Others will ask you to open a separate TFSA that can hold only U.S. dollars. For example, TD bank offers a “U.S. Component” TFSA, which attaches to your normal TFSA but will contain only investments bought with U.S. dollars.(2)
Keep in mind: You’ll likely have to pay a conversion fee when you exchange your CAD for USD, no matter what TFSA you have. Most banks and brokers charge around 1 to 2% of the amount you’re trying to exchange.
If your account isn’t designed to hold U.S. dollars, then you might have to buy U.S. stocks with CAD. This isn’t recommended, however, as you’ll have to pay the 1 to 2% conversion fee every time you buy or sell a U.S. stock. The fee may seem small, but it will add up over time, especially if you trade frequently.
Do you have to pay taxes on U.S. stocks in a TFSA?
In some circumstances, you might have to pay taxes on U.S. stocks held within a TFSA.
The Internal Revenue Service (IRS) does not recognize the tax shelter of a TFSA for dividends earned on U.S. stocks. If you’re holding U.S. dividend stocks in your TFSA, then the IRS will expect you to pay a withholding tax of 15% on the dividends you earn.
But this only applies for dividends earned on U.S. stocks, not capital gains. If you sell a U.S. stock for a profit within your TFSA, the IRS won’t tax the amount you earned.
For example, let’s say you buy 20 shares of Coca-Cola for US$65 per share. Let’s also assume Coca-Cola stock has a dividend yield of 2.5%.
Without the IRS’s withholding tax on U.S. stocks in a TFSA, you’ll have to pay 15% in withholding taxes, or roughly $4.88. After factoring in the tax, you would earn roughly $1.63 per share in dividends, or $32.50 for your 20 shares. But since you’re holding 15% tax, your dividend yield would be 2.125%, not 2.5%.
Now let’s say Coca-Cola stock is valued at $70 and you sell your 20 shares. You’ll earn $5 per share in capital gains and $100 for all 20. Since this is a capital gain and not a dividend, the IRS will not tax your earnings.
Do you pay taxes on U.S. dividend stocks in an RRSP?
No. Even though the IRS doesn’t recognize the tax shelter of a TFSA for dividends, they do recognize it for the Registered Retirement Savings Plan (RRSP). If you earn dividends on U.S. stocks in an RRSP, you won’t pay a withholding tax.
Should you hold international stocks in a TFSA?
To have a well-diversified portfolio, it’s advisable to invest in U.S. stocks. Whether or not you hold those in a TFSA depends entirely on your goals, the stocks you expect to buy, and the contribution space you have left in your RRSP and TFSA.
If your goal is to invest in U.S. dividend stocks for the long term, it’s probably best to hold them in an RRSP. You won’t pay the 15% withholding tax on the dividends you earn, which could otherwise eat into your overall earnings.
However, this won’t work for everyone, especially if you would like to use your dividends as passive income and withdraw them frequently before you retire. In this case, the CRA will hit you with their own withholding tax, which could be between 10 to 30% of the amount you withdraw. Not only that but you’ll have to count your withdrawals as taxable income and pay taxes at your marginal tax rate.
For non-dividend U.S. stocks, holding them in TFSA could be a smart choice. Like Canadian stocks, you won’t pay a capital gains tax on U.S. stocks when you sell them for a gain. And unlike RRSPs, you won’t pay taxes when you withdraw money from your TFSA before retirement.
As far as holding U.S. dividend stocks in your TFSA goes, it’s tricky. It might be beneficial if you don’t have contribution space in your RRSP, or you plan to withdraw your dividend earnings frequently before retirement. Talk to your financial advisor or wealth planner for more specific advice.