Penalty for holding dividend stocks in a TFSA?

There are tax issues involved if you earn dividends inside your Tax-Free Savings Account

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Q: I hold blue-chip stocks that pay a dividend in my TFSAs. I have been told by a friend that I will be penalized for this. What does he mean?

— Morgan

A: “Penalized” is a strong word, but there are some tax issues to be aware of when you hold dividend stocks in a TFSA.

Let’s start with one of the most common misunderstandings: that holding Canadian stocks in a TFSA (or an RRSP) means you’re forfeiting the dividend tax credit. Canadian dividends are taxed favourably: an Ontario investor who earns $50,000 would pay just $64 in taxes on an additional $1,000 in Canadian dividends after accounting for the tax credit. That same $1,000 in interest income would come with a tax bill of almost $300. That’s why, if your TFSA and RRSP are both maxed out, it often does make sense to hold Canadian stocks in a non-registered account and use the TFSA and RRSP for assets that are taxed less favourably.

However, if you have plenty of room in your TFSA, there’s nothing wrong with holding Canadian blue chips there. It’s true you won’t be able to claim the dividend tax credit, but that’s because you’re paying zero tax on the dividends already. Holding your stocks in the TFSA also means all the capital gains will be tax-free.

If your blue chip stocks are U.S. dividend payers, there’s another tax issue to understand: the U.S. imposes a 15% withholding tax on dividends paid to Canadians. However, if you hold your U.S. stocks in an RRSP, this withholding tax does not apply. And if you hold them in a non-registered account, you can recover it by claiming the foreign tax credit on your return. Unfortunately, you can’t avoid the withholding tax in a TFSA.

With that in mind, it might be better to hold U.S. blue chips inside your RRSP rather than your TFSA. But again, you need to consider the big picture. If your registered accounts are not maxed out, it is certainly better to hold U.S. dividend payers in a TFSA than in a non-registered account. Yes, you will lose the withholding tax, but the remaining dividends and all of the capital gains will be tax-free forever.

Dan Bortolotti, CFP, CIM, associate portfolio manager with PWL Capital in Toronto

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5 comments on “Penalty for holding dividend stocks in a TFSA?

  1. Thank you. Very useful guidance to help folks with investments, and I hesitate to find any negativity in such a helpful article, but I would never be so optimistic as to include the last word in your last sentence, “forever”. This is especially so when it comes to ever changing government programs.

    Reply

  2. It’s not always advantageous to have all Canadian stocks in a non-registered account, even if you maxed out your registered accounts.
    For example, if you are in a low tax bracket and don’t want to lose withholding taxes on European stocks, then it may make sense to place some Canadian stocks within TFSA and have international stocks in a non-registered account.

    Reply

  3. While holding US dividend paying stocks in your TFSA will result in a 15% withholding tax, placing them in your RRSP will get them taxed as income when you withdraw them. Which means they get hit with your marginal tax rate that could be higher than 30%. So you can suffer the 15% US tax in a TFSA and withdraw everything else, including capital gains, tax free, or wait for the Canadian tax hit when you withdraw from your RRSP

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  4. Good info. But how do I get Canadian Stocks or Canadian Dividend stocks in my TFSA ?
    The bank doesn’t do it, who does ?

    Reply

  5. The article keeps mentioning the 15% withholding tax on US stocks. It’s important for new investors to know that the usual tax withholding is 30%. Canadian investors must complete a form to ensure the tax on dividends is reduced from 30% to 15%

    Reply

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