The Tax-Free Financial savings Account’s tax-free standing comes with one huge asterisk that many buyers miss. For those who personal U.S. shares or U.S.-listed exchange-traded funds (ETFs) inside a TFSA, 15% of the dividend is misplaced to overseas withholding tax.
This tax is unavoidable. It’s withheld at supply by the IRS, and there’s no technique to recuperate it inside a TFSA. The one registered account that avoids this drag is a Registered Retirement Financial savings Plan (RRSP).
Given how highly effective the TFSA is, that is typically a non-issue for newer buyers. In case your U.S. publicity is modest, otherwise you concentrate on firms that pay little or no dividends, the affect is small.
Nonetheless, as your portfolio grows, that is one thing price optimizing earlier somewhat than later. Here’s what you could know for those who’re contemplating investing in U.S. shares or ETFs in a TFSA.
What occurs for those who personal a U.S. ETF or inventory
Take the Vanguard S&P 500 ETF (NYSEMKT:VOO), for instance. It is likely one of the hottest U.S. fairness ETFs, with a really low 0.03% expense ratio.
As a Canadian investor, shopping for VOO additionally means changing your {dollars} into U.S. forex. With trendy brokerages, that step is cheaper and simpler than it was once, however it doesn’t clear up the core subject.
Inside a TFSA, the roughly 1.1% 30-day SEC yield paid by VOO is mechanically lowered by 15% as a result of overseas withholding tax. You by no means see that cash, and you can’t declare it again.
When these smaller dividends are reinvested over time, the misplaced earnings creates a modest however actual drag on long-term development. Due to this, changing forex to purchase VOO in a TFSA hardly ever is sensible when a Canadian-listed various exists.
The Canadian possibility
An easier method is the Vanguard S&P 500 Index ETF (TSX: VFV). It offers the identical S&P 500 publicity as VOO however trades in Canadian {dollars}, so there is no such thing as a must convert forex.
The expense ratio is larger at 0.09%, however in greenback phrases, the distinction is minimal even on massive balances. The yield is decrease at about 0.92%, reflecting each the upper payment and the identical underlying overseas withholding tax that applies to U.S. dividends.
Economically, the 2 ETFs are very related. From a sensible standpoint, VFV is just extra handy for Canadian buyers utilizing a TFSA, or in case your brokerage doesn’t provide low-cost forex conversion.
