Fine print TFSA rules affecting US stocks

The Tax-Free Savings Account (TFSA) is one of the best wealth-building tools available to Canadians. Tax-free growth. Tax-free withdrawals. No impact on government benefits.

But when it comes to US stocks, there’s fine print that many investors overlook – and it can silently lower your returns.

Before you load your TFSA with US blue chips or high-yield dividend stocks, here are three rules that can significantly impact your portfolio that you should know.

The dividend tax of 15%

The biggest surprise for many investors is that US dividends are in a TFSA not completely tax free.

Because the TFSA is not recognized under the Canada-US tax treaty, dividends paid by US companies are subject to a 15% non-refundable withholding tax. That tax is automatically deducted by the Internal Revenue Service (IRS) before the dividend even hits your account.

Capital gains remain tax-free, but income investors feel the pinch.

For example, if you hold Comcast (NASDAQ:CMCSA), which yields about 4.2%, the actual yield within a TFSA drops to about 3.6% after the 15% withholding tax. With an annual dividend of $500, you will receive only $425.

The same rule applies to Canadian-listed Exchange Traded Funds (ETFs) that hold U.S. stocks. For example, Vanguard S&P 500 Index ETF still faces the same US dividend withholding at fund level.

How to respond? Consider placing high-yield US dividend stocks in a Registered Retirement Savings Plan (RRSP) or Registered Retirement Income Fund (RRIF), where the treaty exempts them from withholding tax. Meanwhile, quality growth-oriented names that pay little or no dividends include Amazon – may be a better fit for a TFSA.

Currency Conversion: The Hidden Costs of Foreign Stock Trading

Another overlooked barrier comes from exchange costs.

When you buy US stocks with Canadian dollars, most brokers charge a currency conversion margin of 1.5% to 2% – on top of trading commissions. If you trade regularly, these costs will gradually add up.

There are two practical solutions.

First, consider opening a US dollar-denominated TFSA. This allows you to exchange currencies once and then trade US securities without repeated exchange fees.

Second, some investors use Canadian depositary receipts (CDRs), which trade in Canadian dollars and provide built-in currency hedging. While this is useful, investors need to understand its structure and embedded costs before relying on it over the long term. It may make sense to use CDRs if the stocks you want to invest in are available there and U.S. dollars are strong against Canadian dollars.

Currency friction may seem small, but minimizing it can significantly increase compound returns over decades.

The day trading trap

Finally, the TFSA is designed for investments and not for active trading.

If the Canada Revenue Agency (CRA) determines that your activity is akin to “conducting a business” – that is, frequent, speculative trading – your profits could become fully taxable.

There is no clear rule defining how many transactions give rise to audit. Instead, the CRA takes into account factors such as frequency, holding period, knowledge of the markets and intent. In short, treat your TFSA like a long-term compounding machine, not a trading account.

Takeaway for investors

The TFSA remains an exceptional instrument – ​​but US stocks introduce nuances that investors should not ignore:

• US dividends are subject to a 15% non-refundable withholding tax.
• Currency conversion fees can erode returns if not managed.
• Excessive trading risks losing the TFSA’s tax-exempt status.

If used wisely, a TFSA can still be an ideal home for growth-oriented US stocks. But if you understand the fine print, you’ll keep more of what your investments earn – which can make a surprisingly big difference over time.