TFSA Investors: Wait for US stocks. TSX dividends are tax free
The flexibility of the Tax Free Savings Account (TFSA) is second to none, as users have so much leeway to get the most out of their accounts. One of the main features is international diversification. This means that you can hold US and foreign securities in your portfolio.
Some financial experts believe it makes sense to set aside home country bias if selected foreign assets can offer higher returns than their Canadian counterparts. However, not everyone would agree that this asset allocation strategy is beneficial to TFSA investors. What is the point if there are tax consequences in a tax-advantaged account?
No tax exemption
Prior to the introduction of the TFSA in 2009, the Income Tax Act lifted foreign content limits in a registered retirement savings plan (RRSP). The same rule applies to the TFSA. Thus, Canadians can hold US stocks in either account. If the denomination is in foreign currency, the law requires that the total amount of the contribution does not exceed the annual limit in Canadian dollars
Remember that any interest, earnings or dividends you earn in a TFSA are 100% exempt from Canadian income tax. However, dividend income from US stocks is subject to a 15% withholding tax.
International diversification loses its appeal if the final return on investment declines when the United States slaps you with the tax. In addition, you cannot reclaim this tax by way of a foreign tax credit or deduction in calculating your taxable income.
Not included in the tax treaty
There is an important difference in the treatment of TFSAs and RRSPs with respect to qualified investments in US exchanges. The Canada-U.S. Tax treaty grants a U.S. tax exemption for investments held in RRSPs and registered retirement income funds (RRIFs) only.
The TFSA is out of the loop because it is not considered a retirement plan, like an RRSP or RRIF. Please note that interest income and capital gains earned on US securities by any Canadian will only be taxable in their country of origin under said tax treaty. Therefore, if tax is your consideration, it is best to delay your intention to include US stocks in your TFSA.
# 1 source of tax-free dividends
Canadians do not have to cross the border to find suitable anchor stock in their TFSA. Most TFSA users have Enbridge (TSX: ENB) (NYSE: ENB) as a source of non-taxable dividend income. The $ 80.57 billion premium energy infrastructure company is distinguished by reliability and growing dividends.
Even when oil prices were extremely volatile, the leading energy stock dividend grew at a compound annual growth rate of 8.85%. The current stock price is below $ 50 (only $ 39.86 per share), while the dividend yield is 6.78%. If you are a long-term investor, any investment amount will double in less than 11 years.
Enbridge’s total return over the past 45.4 years is 44,335.81% (CAGR 14.38%). This dividend aristocrat is a strong buy regardless of the market environment. In the first quarter of 2021 (quarter ended March 31, 2021), Enbridge made full use of its four blue chip businesses. The results have been strong operational performance and financial results.
Dividends should be secure given heavily contracted assets with blue chip clients and demand-resistant franchises. Enbridge will likely do better with the recovery in global economic activity.
At the end of the line
Use your TFSA to the full and maximize your contribution limits each year if finances allow. Avoid paying taxes by focusing on Canadian assets rather than U.S. assets.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a premium Motley Fool service or advisor. We are Motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer, so we’re posting sometimes articles that may not conform to recommendations, rankings or other content. .
Silly contributor Christopher Liew has no position in any of the listed securities. The Motley Fool owns shares and recommends Enbridge.