Can you hold US stocks in TFSA? What about other foreign stocks? Will the gains on US stocks get taxed when held in a TFSA?
This post will answer these questions and help you decide if you should hold US stocks in your TFSA.
Can you buy foreign stocks in TFSA?
You can buy and hold foreign stocks in your TFSA as long as they are listed on a designated stock exchange. The designation is made by the Minister of Finance and there are currently 47 designated stock exchanges.
Twelve (12) of these are U.S. stock exchanges including NASDAQ and NYSE
The Canada Revenue Agency (CRA) also allows a broad list of qualified investment to be held in a TFSA including shares of corporations, mutual funds, bonds, REITs and many more.
Therefore, except for a few derivatives, Canadians can hold any foreign security that is listed on designated stock exchanges.
Do I have to pay taxes on US Stocks in TFSA?
As far as CRA is concerned, there are no distinctions between Canadian securities and U.S. stocks in your tax-free savings account. Any returns including dividends, interest or capital gains earned on U.S. stocks in a TFSA are not taxed by the CRA.
With a few exceptions, gains in TFSAs are completely tax-free both while in the account and upon withdrawal. The few exceptions are over-contributing to a TFSA, holding non-qualified or prohibited investments, non-resident contributions and taxes payable on an advantage.
However, you may have to pay some U.S. withholding tax depending on the type of return you receive on the US stocks in your TFSA.
Withholding Tax on US Stocks in TFSA
The Internal Revenue Service, IRS, is the federal agency responsible for collecting and enforcing tax laws in the United States of America. In other words, it is the U.S. equivalent of CRA.
Unfortunately, IRS does not recognize the tax-free status of the TFSA like it does for RRSP and other retirement accounts. That means, some of your investment returns will be subject to a withholding tax – as high as 30% without the proper documentations.
Fortunately, Canadians can get a reduced rate of 15% under the Canada-US tax treaty. You’ll need to fill Form W-8BEN (Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting) for individuals or W-8BEN-E for corporate accounts.
In general, you would have signed these forms when opening your brokerage accounts in Canada.
For example, you would sign the form when opening a new account with Wealthsimple. At Questrade, you’ll get the 15% by default as long as you provide a valid ID that shows you’re the Canadian resident.
If you can’t remember completing the form or you’re not sure, please contact your brokerage.
Withholding Taxes and Foreign Tax Credit
Canadians can get exposure to US stocks in different ways. 4 of the popular ones include:
- Buying the US Stocks directly
- A U.S. listed ETF like VTI
- Canadian listed ETFs that hold US-listed ETFs e.g. VUN; or
- Canadian ETF that holds the US stocks directly
With RRSPs, how you choose to buy US stocks will dictate whether you’ll pay the withholding tax or not. But it makes no difference in a TFSA or non-registered accounts.
But note that U.S. withholding taxes paid in non-registered accounts can be recovered by claiming the foreign tax credit when you file your income tax returns. This effectively brings the tax to 0%.
Unfortunately, you won’t be able to offset the withholding tax paid in your TFSA with the foreign tax credit. The same treatment applies to foreign withholding taxes in any of your registered accounts including RRSP and RESP.
So assuming you have the proper documentation in place, the tax effect of holding US stocks in TFSA are below:
- Dividends – 15%
- Interest – 0%
- Capital Gains – 0%
That means, you should hold non-dividend paying or growth stock in a TFSA to avoid the tax hit. Then hold dividend stocks in non-registered accounts where you can offset the tax by claiming the foreign tax credit.
And if you’re using an RRSP, then it’s best to hold the US stocks directly or through US listed ETFs.
Should You hold US Stocks in your TFSA?
Despite the withholding tax, holding some US stocks in a TFSA could significantly increase the expected returns of your portfolio.
With the right allocation to US stocks, your TFSA portfolio will be exposed to some of the largest companies in the world and reduce the Canadian economy’s heavy reliance on financials and energy stocks.
But instead of making the decision in isolation, you should consider your entire portfolio and the asset types that’ll balance maximizing returns and minimizing taxes.
This would mean making a conscious decision on where to put different type of securities. For example, it could mean only buying Canadian stocks in your TFSA and foreign stocks in your RRSP and non-registered accounts.
But it’s not that straightforward. Imagine you’ve maximized your RRSP contribution room and can only invest in either TFSA or non-registered account. Do you invest in the TFSA and pay the 15% US withholding tax on any dividend received but nothing on the capital gains?
Or use a non-registered account to avoid the US tax, but potentially pay higher in capital gains tax whenever you sell the stock?
Bottom line is: The right combination will vary depending on your personal circumstances such as available contribution room in your registered accounts, marginal tax rate and so on.
Best TFSA Investments
The best investment for your TFSA is the one that help you minimize the overall tax you pay on your total portfolio, both now and in the future.
That means you should take a top-down approach.
Start with the “what”. What are your financial goals and the best asset allocation that’ll help you achieve them? Then consider the best accounts to use – TFSA, RRSP, RESP or non-registered account.
Finally, decide on the type of investments to hold and keep an eye on the investment costs.
Consider using asset-allocation ETFs. It is one of easiest and fastest ways to build a diversified portfolio at a fraction of the cost of using individual stocks.
And the best part is you’ll never have to worry about rebalancing your portfolio. The ETF holdings are automatically rebalanced at regular intervals by the ETF providers.