If you’ve ever considered investing across the border, buying US stocks in TFSA might have crossed your mind. The Tax-Free Savings Account (TFSA) is a powerful tool for Canadians to grow their wealth without worrying about taxes.
However, when you add US stocks into the mix, the tax-free promise comes with a few caveats that can affect your returns. Let’s explore how US stocks work in a TFSA and whether it’s the right move for your financial goals.
What is a TFSA?
The TFSA is a Canadian savings and investment account designed to help you grow your money tax-free. Introduced in 2009, it allows Canadians to contribute annually up to a government-mandated limit, which accumulates over the years if unused. Contributions and any investment growth—whether from interest, dividends, or capital gains—are not taxed when withdrawn, making it an excellent choice for long-term savings and investing.
Unlike an RRSP, TFSA withdrawals don’t affect your taxable income, which is one reason it’s such a flexible tool. But while you can hold a variety of investments in your TFSA, such as Canadian stocks, bonds, and mutual funds, investing in US stocks adds a layer of complexity.
Why Invest in US Stocks?
For many Canadians, the allure of US stocks is hard to resist. The US is home to some of the most well-known and innovative companies, like Apple, Google, and Amazon, that dominate global markets and set trends. Investing in these companies provides access to industries that may not have as much representation in the Canadian market, such as technology, healthcare, and entertainment.
Additionally, the US stock market has a long history of strong performance. While past performance isn’t a guarantee of future returns, the broader US indices, like the S&P 500, have historically delivered solid growth over the long term. For Canadians looking to diversify beyond domestic investments, US stocks offer the chance to tap into global opportunities and reduce reliance on the Canadian economy.
The Benefits of Buying US Stocks in TFSA
1. Tax-Free Capital Gains
One of the most attractive benefits of buying US stocks in a TFSA is the ability to enjoy tax-free capital gains. If the US stocks you own double, triple, or even more in value, you won’t have to worry about paying capital gains tax on the growth. In contrast, holding these stocks in a taxable account would require you to report and pay taxes on any gains when you sell.
Tax-free capital gains make the TFSA an excellent place for long-term growth-focused investments. You can reinvest your profits without the burden of taxes, allowing your wealth to compound faster. This makes it especially appealing for investors who want to hold onto high-potential US growth stocks over many years.
2. Diversification Benefits
Adding US stocks to your portfolio can significantly improve diversification. The Canadian stock market is heavily concentrated in sectors like financials, energy, and materials, which can leave investors overexposed to economic shifts within these industries. By buying US stocks in TFSA, you gain exposure to a broader range of sectors, including technology, healthcare, and consumer goods, which are more prominent in the US.
Diversification reduces risk and helps balance your portfolio during economic downturns. For example, during a slump in oil prices, US technology stocks could perform well and offset losses, providing more stability to your investments.
3. Simple and Convenient
Another advantage of buying US stocks in TFSA is the ease of investing. Many Canadian brokerage platforms allow you to purchase US stocks directly through your TFSA. While there are some currency conversion considerations, the overall process is straightforward, making it accessible even for novice investors.
The Drawbacks of Buying US Stocks in TFSA
1. Foreign Withholding Tax on Dividends
A major downside of holding US stocks in a TFSA is the 15% foreign withholding tax on dividends. This applies to both US-listed ETFs like VOO and Canadian-listed ETFs like XSP. When US companies pay dividends to non-resident investors, the Internal Revenue Service (IRS) automatically deducts 15% before the dividend reaches your account.
For example, if your US stock pays $1,000 in annual dividends, you’ll only receive $850 after the withholding tax. Since the TFSA is a tax-free account, you can’t claim a foreign tax credit for the withheld amount, unlike with non-registered accounts. This makes dividend-focused US stocks less attractive for a TFSA compared to Canadian dividend stocks.
2. Currency Conversion Costs
If you’re funding your TFSA in Canadian dollars but buying US stocks, your broker will convert your CAD to USD for the purchase. Most brokers charge a spread on currency conversions, which can range from 1.5% to 2.5%, significantly adding to your costs.
Currency conversion fees are often overlooked but can reduce your overall returns, especially if you frequently buy and sell US stocks. Understanding and managing these fees is crucial to maximizing your investments.
3. US Estate Tax Implications
While less common, US estate tax can be a concern for Canadians with substantial US investments. For estates worth over $60,000 USD, US assets like stocks can be subject to estate tax. Although this typically applies to high-net-worth individuals, it’s worth considering if you plan to hold a large portion of your portfolio in US stocks within your TFSA.
Strategies to Minimize Drawbacks
1. Hold Growth Stocks in Your TFSA
To avoid the impact of withholding taxes, consider focusing on US growth stocks that reinvest their profits rather than paying dividends. Companies like Amazon are prime examples of growth stocks that aim to maximize shareholder value through capital appreciation rather than regular payouts.
By prioritizing growth stocks in your TFSA, you can still benefit from the tax-free growth without losing a portion of your returns to dividend taxes.
2. Leverage Norbert’s Gambit for Currency Conversion
Norbert’s Gambit is a strategy that allows you to convert CAD to USD at a much lower cost than traditional currency exchange fees. It involves buying a dual-listed stock on a Canadian exchange, transferring it to a US exchange, and then selling it in USD.
While this process requires a bit more effort, the savings on currency conversion fees can be significant, especially for larger transactions. For regular investors looking to buy US stocks in TFSA, Norbert’s Gambit is a valuable tool to reduce costs.
3. Consider an RRSP for Dividend Stocks
If your goal is to invest in US dividend-paying stocks, holding them in an RRSP might be a better option. Thanks to the Canada-US Tax Treaty, US dividends in an RRSP are exempt from the 15% withholding tax. This makes the RRSP a more tax-efficient account for dividend-focused US stocks, allowing you to maximize your returns.
However, keep in mind that the tax treaty applies to US individual stocks and US-listed ETFs, but not to Canadian-listed ETFs like XSP.
How to Buy US Stocks in TFSA
1. Choose the Right Broker
Not all brokers are created equal when it comes to buying US stocks in a TFSA. Look for platforms that offer access to US markets, competitive currency conversion rates, and tools for managing your investments. Popular choices include Questrade, Wealthsimple, and Interactive Brokers.
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2. Fund Your TFSA
Deposit funds into your TFSA, keeping in mind your contribution room. If you’re unsure about your available room, you can check with the CRA through your online My Account portal. Overcontributing can result in penalties, so it’s essential to stay within your limit.
3. Convert CAD to USD
If you’re buying US stocks, you’ll need USD to complete your purchase. While most brokers automatically handle this conversion, using Norbert’s Gambit or opening a US dollar TFSA account can save you on currency conversion fees.
4. Select and Buy Your Stocks
Once your funds are in USD, research and choose the US stocks that align with your investment goals. Diversify your holdings to reduce risk and ensure a balanced portfolio.
A Personal Take on Buying US Stocks in TFSA
When I started investing in US stocks through my TFSA, I was excited about owning shares of big-name companies like Amazon and Google. However, I quickly learned about the impact of foreign withholding tax on dividends, which reduced my returns on dividend-paying stocks. This experience taught me to focus on growth-oriented US companies in my TFSA while keeping dividend stocks in my RRSP.
Using Norbert’s Gambit to handle currency conversions was pivotal, saving me hundreds of dollars in fees over time. By being mindful of these details, I was able to make the most of my investments while avoiding unnecessary costs.
Final Thoughts
Buying US stocks in TFSA can be a smart move if you approach it with a clear understanding of the benefits and drawbacks. While the tax-free growth and diversification opportunities are undeniable, foreign withholding taxes, currency conversion fees, and estate tax implications require careful planning.
If you’re drawn to the potential of US markets, prioritize growth stocks in your TFSA and consider an RRSP for dividend-paying investments. By leveraging strategies like Norbert’s Gambit and diversifying your portfolio, you can maximize your returns and achieve your financial goals.
Have you considered buying US stocks in your TFSA? Share your experiences or questions in the comments below—I’d love to hear from you!
