What the TFSA Fine Print Says About Holding U.S. Stocks

One of the biggest selling points of the Tax-Free Savings Account (TFSA) is right there in the name: tax-free. If your investments compound over decades, all that growth stays sheltered from the Canada Revenue Agency. Even Canadian dividends earned inside the account remain tax-free.

In many situations, that tax advantage is extremely powerful. What many newer investors do not realize, though, is that there is a small piece of fine print when it comes to holding U.S. stocks or U.S.-listed exchange-traded funds (ETFs) inside a TFSA.

Specifically, the U.S. government still withholds 15% of dividend payments before they even reach your account. That withholding tax applies even though the TFSA is tax-free in Canada.

Should investors actually worry about this?

In most cases, probably not. Many investors spend far too much time obsessing over withholding taxes while ignoring the much bigger driver of long-term wealth creation: total returns.

A 15% withholding tax on a 1% dividend yield only creates a drag of 0.15% annually. That is relatively minor compared to the long-term tax savings generated by sheltering capital gains and portfolio growth inside a TFSA.

There are some exceptions, though. If you own very high-yielding U.S. dividend stocks or income-focused ETFs, the withholding tax becomes more noticeable. In those situations, it can sometimes make more sense to prioritize holding those investments inside a Registered Retirement Savings Plan (RRSP). Thanks to the Canada-U.S. tax treaty, U.S. dividends paid inside an RRSP are generally exempt from the 15% withholding tax.

Still, investors should avoid letting the tax tail wag the dog. The TFSA remains one of the most powerful investing accounts available to Canadians. In many cases, the tax-free capital gains and long-term compounding benefits easily outweigh the relatively small withholding tax drag tied to U.S. dividends.

The post What the TFSA Fine Print Says About Holding U.S. Stocks appeared first on The Motley Fool Canada.

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More reading

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