The Tax-Free Savings Account (TFSA) was introduced in Canada in 2009 and has since gained popularity among Canadians as a beneficial savings tool. However, it’s important to consider the potential tax implications when holding foreign investments in a TFSA.
For Canadian clients who hold foreign investments in their TFSA, dividends received within the account are tax-free in Canada. However, there may be a withholding tax imposed on these dividends.
On the other hand, U.S. citizens face different considerations. TFSA accounts are not recognized as tax-free by the United States, which means that U.S. citizens are required to pay income taxes on the account’s income and capital gains annually.
While it is possible to hold foreign stocks in a TFSA, they must be listed on approved stock exchanges. Currently, there are 47 designated stock exchanges, including 12 in the United States, such as NASDAQ and NYSE.
Furthermore, the Canada Revenue Agency (CRA) allows a wide range of qualified investments to be held in a TFSA. These can include corporate shares, mutual funds, bonds, real estate investment trusts (REITs), and more.
In summary, Canadian investors can hold foreign securities traded on certain designated stock exchanges within their TFSA, with a few exceptions for certain derivatives.
Understanding Tax Implications of Holding US Stocks in a TFSA
When it comes to US stocks held in a Tax-Free Savings Account (TFSA), the Canada Revenue Agency (CRA) treats them similarly to Canadian securities. Here’s what you need to know about the tax implications:
- Tax-Free Returns: The CRA does not tax any returns earned on US stocks held in a TFSA, including dividends, interest, and capital gains. Gains within a TFSA, with a few exceptions, are completely tax-free both while in the account and upon withdrawal.
- US Withholding Tax: Depending on the type of return you receive on your US stocks in a TFSA, you may be subject to US withholding tax. The amount of withholding tax can vary, typically around 15% for dividends. This tax is withheld by the US and does not impact the tax-free status of your TFSA.
- Foreign Tax Credit: In non-registered accounts, you can recover US withholding taxes by claiming a foreign tax credit when filing your income tax returns. This means that the tax paid can be offset, resulting in a tax rate of 0%. However, you cannot use the foreign tax credit to offset withholding taxes paid on US stocks held in a TFSA.
- Investing Strategies: To minimize tax impact, it is advisable to invest in non-dividend-paying or growth stocks in a TFSA. Dividend stocks can be kept in non-registered accounts, where you can utilize the foreign tax credit to reduce the taxes owed.
- RRSP Considerations: In Registered Retirement Savings Plans (RRSPs), the way you choose to invest in US stocks determines whether you are subject to withholding tax. The tax treatment is the same for both TFSA-registered and non-registered accounts.
If you are utilizing an RRSP, it is recommended to hold US stocks directly or through US-listed ETFs to optimize your investment strategy.
In summary, while returns on US stocks held in a TFSA are generally tax-free, there may be US withholding tax implications. It is important to consider your investment choices and consult a tax professional to make informed decisions based on your specific situation.
Should you consider buying US stocks?
A Tax-Free Savings Account (TFSA) is a great tool for safeguarding your money while enjoying tax benefits. The income generated within a TFSA, whether from dividends or capital gains, is tax-free. For long-term investors, this presents an excellent opportunity to grow their portfolio without worrying about taxes upon withdrawal.
When it comes to choosing stocks for your TFSA, you have flexibility. As long as the stock is listed on major markets like the TSX, NASDAQ, or NYSE, you can include it in your TFSA.
There are various approved exchanges where you can purchase stocks to trade on, and you are not limited to Canadian or North American equities alone.
However, there is an important consideration when it comes to earning dividends. If you invest in US-based stocks that pay dividends, the IRS may impose a withholding tax of up to 30% on those dividends. You can reduce this rate to 15% by completing a tax form, such as the W-8BEN or W-9.
It’s essential to note that the withheld tax cannot be recovered as it is not deductible on your tax return.
If your investment strategy focuses on growth stocks that do not pay dividends, such as Amazon, it could be a suitable choice for your TFSA.
Ultimately, the decision to buy US stocks through a TFSA depends on your investment goals, risk tolerance, and understanding of the tax implications. It’s advisable to consult with a financial advisor or tax professional to make informed decisions aligned with your financial objectives.
The optimal choice for TFSA investors is as follows:
If your primary goal is to achieve high returns, consider investing in an ETF such as the BMO NASDAQ 100 Equity Hedged to CAD Index ETF (TSX: ZQQ).
This ETF not only includes top-performing stocks like Amazon but also provides exposure to other leading NASDAQ companies such as Apple, Microsoft, Facebook, and many more.
The fund has delivered impressive year-to-date returns of over 28%, outperforming the NASDAQ’s average return of approximately 25%.
Choosing the best investments for your TFSA requires careful consideration of your overall tax strategy and financial goals.
Here’s a step-by-step approach to help you make informed decisions:
- Start by determining your optimal asset allocation and defining your financial goals. This will guide your investment choices and help you align your portfolio with your objectives.
- Consider utilizing different accounts such as TFSA, RRSP, RESP, or non-registered accounts strategically to maximize tax efficiency and flexibility.
- Once you have clarity on your asset allocation, explore the option of using Exchange-Traded Funds (ETFs). ETFs offer a simple and cost-effective way to create a diversified portfolio compared to investing in individual stocks.
- Look for brokerage platforms like Questrade or Wealthsimple Trade that offer commission-free ETF trading. This can help reduce your investment costs and maximize your returns.
- One of the advantages of investing in ETFs is that they are designed to automatically rebalance their holdings at regular intervals. This means you won’t have to worry about manually adjusting your portfolio over time.
By following these steps, you can build a well-diversified TFSA portfolio that aligns with your financial goals, minimizes costs, and provides long-term growth potential.