The tax-free account that isn't quite tax-free
If you hold US stocks or US-focused ETFs in your TFSA, the US government keeps 15% of every dividend before it reaches you. You never see a bill. You never get a slip. And you can't claim it back.
Most Canadians don't know this is happening, because the money just quietly doesn't arrive. The good news: for most index investors the cost is small. The bad news: for dividend-focused investors, it can add up to tens of thousands of dollars over a lifetime.
Here's why it happens, what it really costs, and when it's worth doing something about.
Why the US taxes your TFSA
The US taxes dividends paid to foreign investors. Under the Canada-US tax treaty, that rate is cut to 15% for Canadians.
The treaty goes further for retirement accounts. The US recognizes the RRSP, RRIF and locked-in retirement accounts as pension plans, so US dividends paid into them can be exempt from withholding entirely.
The TFSA didn't exist when those treaty provisions were written, and the US has never recognized it. Neither are the RESP, RDSP or FHSA. To the IRS, your TFSA is just an ordinary account.
In a regular taxable account, you'd at least get the 15% back as a foreign tax credit on your Canadian return. But TFSA income isn't taxed in Canada, so there's nothing to claim the credit against. The money is simply gone.
One important limit: this only applies to dividends. Selling a US stock at a profit inside your TFSA triggers no US tax. Growth stocks that pay little or no dividend are barely affected.
Does it matter how you hold US stocks?
In a TFSA, no. Whether you buy US stocks directly, a US-listed ETF like VTI, or a Canadian-listed ETF like VFV or XUU, the 15% is lost either way. With Canadian-listed ETFs, it's just taken inside the fund, so you never see it.
In an RRSP, it matters a lot. Here's how the 15% US withholding tax on US stock dividends plays out:
| How you hold US stocks | Example | TFSA, FHSA, RESP | RRSP, RRIF | Taxable account |
|---|---|---|---|---|
| US-listed stock or ETF, held directly | Apple, VTI, VOO | 15% lost | Exempt | 15% withheld, usually recoverable as a tax credit |
| Canadian-listed ETF holding US stocks or a US ETF | VFV, XUU, VUN, ZSP | 15% lost | 15% lost | 15% withheld, usually recoverable as a tax credit |
| All-in-one ETF with a US portion | XEQT, VEQT | 15% lost on the US portion | 15% lost on the US portion | Usually recoverable |
That second row surprises people. The RRSP exemption only works when the account holds the US security directly. Buy VFV in your RRSP and you pay the 15% anyway.
International (non-US) stocks work similarly but with their own country's withholding rates, and some fund structures add a second layer of tax. Justin Bender and Dan Bortolotti of PWL Capital cover this in detail in their foreign withholding tax guide.
What it really costs
The yearly cost equals your dividend yield times 15%. That makes the yield the whole story.
Imagine two investors, each with $50,000 of US stocks in a TFSA, each earning 7% a year in total before the withholding tax, for 25 years.
| Index investor (S&P 500 ETF) | Dividend investor (high-yield US stocks) | |
|---|---|---|
| Dividend yield | about 1.3% | about 4% |
| Lost to US tax in year one | about $98 | about $300 |
| Yearly drag on returns | about 0.2% | about 0.6% |
| Value after 25 years, no withholding | about $271,000 | about $271,000 |
| Value after 25 years, with withholding | about $259,000 | about $236,000 |
| Total cost over 25 years | about $12,000 | about $35,000 |
These are illustrations, not predictions. Real returns and yields will differ.
For the index investor, $12,000 over 25 years is real money but modest. It's roughly the same as an extra 0.2% management fee. For the dividend investor chasing yield in US stocks, the cost is nearly three times higher.
The balanced view: should you actually care?
Why it's often not a big deal:
- Your TFSA still wins. 15% of a small dividend is minor compared to the tax-free growth and tax-free withdrawals on everything else. Don't abandon US stocks in your TFSA over this.
- Diversification matters more. The US is a huge part of the global market. Avoiding it to save 0.2% a year would be letting the tax tail wag the investment dog.
- The fix has costs too. Getting the RRSP exemption means buying US-listed ETFs, which means converting to US dollars. Norbert's Gambit and brokerage fees can eat the first year or more of savings, especially on small amounts.
- Not everyone has RRSP room, or should use it. For lower-income Canadians, the TFSA is often the better account overall.
When it does matter:
- You're a US dividend investor. High-yield US stocks, REITs and dividend ETFs in a TFSA suffer most.
- You have large RRSP and TFSA balances. At $500,000+, even 0.2% a year is real money, and optimizing where each fund sits pays off.
- You bought VFV in your RRSP thinking it was exempt. It isn't. Only US-listed securities held directly get the exemption.
The fair critique: many Canadians are sold TFSAs as "completely tax-free" by banks and apps without ever hearing about this. It's a legitimate disclosure gap, even if the dollar impact for most people is small.
What to do about it
- Check what's in your TFSA. Look for US stocks, US dividend ETFs and US REITs. Note their dividend yields.
- Keep Canadian dividend stocks in your TFSA. Canadian dividends have no withholding tax, so they're a natural fit.
- Move high-yield US holdings to your RRSP, if you have room, and hold them as US-listed securities directly.
- In your RRSP, prefer US-listed ETFs for US stocks (like VTI or VOO) over Canadian-listed versions (like VFV), if your balance is large enough to justify converting currency.
- In your TFSA, keep it simple. A Canadian-listed US ETF is fine. The 15% applies to every structure there, so pick on fees and convenience.
- Use low-yield US growth holdings in your TFSA if you want US exposure there. Less dividend means less withholding.
- Don't over-engineer a small portfolio. Under roughly $50,000, the savings may not cover the currency conversion costs and extra complexity.
The bottom line
Your TFSA is tax-free in Canada, not in the US. Every US dividend loses 15% on the way in, and there's no way to get it back. For most index investors, that's a small, acceptable cost. For US dividend investors, it's worth rearranging which account holds what.
This article is general education, not tax or investment advice. Your best setup depends on your income, account balances and goals. Consider speaking with a fee-only financial planner or tax professional.
Worked example assumes 7% annual total return, constant yields and no contributions or withdrawals, rounded to the nearest $1,000.