How does a U.S.-dollar TFSA work?

TFSAs have annual contribution limits, and there is a penalty tax of 1% per month for overcontributions. If you have more than one TFSA, it increases the risk of inadvertently overcontributing—even more so if you hold and/or trade in U.S. dollars.

Let’s look at the considerations for your Canadian and U.S. TFSAs, Michelle.

TFSA qualified investments

The Canada Revenue Agency (CRA) outlines the types of investments that can be held in a TFSA. The rules are generally the same for a TFSA as for a registered retirement savings plan (RRSP). The six primary “permitted investments” are:

• cash
• mutual funds
• securities listed on a designated stock exchange
• guaranteed investment certificates (GICs)
• bonds
• certain shares of small business corporations

Securities listed on a designated exchange generally includes stocks, exchange-traded funds (ETFs), real estate investment trusts (REITs) and other publicly traded securities.

U.S. securities that trade on U.S. exchanges like stocks and ETFs are permitted investments, as long as you have a TFSA account that allows you to purchase them. Some TFSAs only allow cash and GICs, for example. Others only allow a limited list of proprietary mutual funds.

Buying U.S. stocks on Canadian exchanges

An investor can buy Canadian depositary receipts (CDRs) in Canadian dollars as an alternative to buying U.S. stocks directly, Michelle. CDRs are securities that represent a fractional ownership of a foreign stock like Apple, Mitsubishi or Volkswagen, and trade on the Cboe Canada stock exchange.

Since CDRs are denominated in Canadian dollars, you do not need to exchange currency or have a U.S.-dollar or other foreign currency account to buy them. One consideration is that they are generally currency hedged, so you will not benefit from the portfolio diversification of owning U.S. dollars or other currencies.

Calculating TFSA contribution room

When you make a contribution to a TFSA in Canadian dollars, the contribution amount is easy to determine. If you contribute foreign funds to a TFSA, the financial institution is responsible for converting the amount to Canadian dollars for the purposes of contribution reporting to the CRA.

As a result, it may be easier to contribute Canadian dollars to a TFSA, or to use a buffer when estimating the exchange trade conversion from U.S. to Canadian dollars when contributing U.S. funds, Michelle. The exact amount of the buffer may be difficult to determine. Currency can fluctuate from day to day, and your financial institution may use a rate that varies by up to a couple percent from the posted exchange rate. To be safe, you could consider building in, say, a 5% buffer, and then ask your financial institution after the fact to confirm the contribution amount in Canadian dollars that it will report to the CRA. And if you are short a few dollars based on your contribution limit, you can top it up in Canadian dollars.

Note that your financial institution bears no responsibility with regards to tracking or confirming your available TFSA room—it simply reports contributions and withdrawals to the CRA. So, it is ultimately up to you to make sure you do not overcontribute.

Also, remember that if you withdraw from one TFSA, you do not get that contribution room back to contribute to the other TFSA immediately. TFSA withdrawals impact your TFSA room the next January 1, with net withdrawals for the year added back to your TFSA room for the subsequent year. If you recontribute too soon, you could be charged the 1% penalty tax.

Foreign withholding tax and TFSAs

When you own U.S. securities or other foreign investments in your TFSA, non-resident withholding tax generally applies. The financial institution is responsible for withholding the tax from dividends and distributions before they hit your account.

The withholding tax is your final tax obligation to a foreign tax authority, so there are no tax-filing obligations for a Canadian resident who is not a U.S. citizen when they buy U.S. securities in their TFSA.

Final thoughts

A diversified portfolio should include U.S. and foreign stocks to complement Canadian stock exposure. So, on that basis, Michelle, using a U.S. TFSA can be a good investment strategy.

You could also explore alternatives to buying U.S. stocks in U.S. dollars, such as CDRs or even U.S.-equity ETFs listed on the Toronto Stock Exchange. If you are contributing U.S. dollars directly to your TFSA, just make sure the contribution amount in Canadian dollars based on the current exchange rate does not put you in an overcontribution position.

Read more from Jason Heath:

• Is real estate the best investment for a Canadian retiree?
• How the Liberals’ re-election impacts RRIFs, taxes and more
• Should you set up a corporation with friends to invest?
• How to avoid RRSP overcontributions when you have a deferred profit sharing plan

About Jason Heath, CFP

Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.

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