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TFSA tax trap

Q – I am new to investing. Until recently, I only invested in mutual funds. Now that I am retired I have decided to do some direct investing through my TSFA.

At the moment, my TSFA is invested in Canadian mutual funds. I would like to expand my TSFA investments into U.S. income securities. Are there any tax implications from investing in U.S. securities within my TSFA? – Roger R.

A – Yes there are. Any dividends from a U.S. company will be subject to a 15% withholding tax. This is because the U.S. does not recognize TFSAs as “retirement accounts”. Dividends paid to RRSPs and RRIFs are not subject to this tax.

This is especially frustrating because there is no way to recover that money. Since it is paid into a registered plan, you cannot use the foreign tax credit when you file your tax return. That money is simply gone. So, in this case, Tax-Free Savings Accounts are not really tax-free.

When Canada and the U.S. get around to renegotiating the tax treaty, this might change. But for the foreseeable future, it’s the rule. You’d be better off earning your dividend income from Canadian companies. – G.P.