TFSA day trading: Do you pay tax?
Tax-free savings accounts (TFSAs) are mostly tax-free. When you buy and sell an investment for a profit, that is generally tax-free inside a TFSA, regardless of the type of investment.
One exception could be if you are day trading in your TFSA. If you are engaging in frequent trading activity, there is a risk your profits could become taxable as business income. For most long-term, buy-and-hold investors, this is not an issue. There’s no specific guideline about what constitutes day trading in your TFSA, but factors like the frequency of trades or the holding periods, for example, could indicate you are using the account this way.
Taxes on U.S. stocks in a TFSA
U.S. stocks held in a TFSA are subject to 15% withholding tax on U.S. dividend income. Withholding tax would apply to other foreign stocks held in a TFSA, with rates starting at 15%, depending on the country. Only Canadian stocks are not subject to withholding tax on their dividends inside a TFSA.
Does this mean you should only hold Canadian stocks in your TFSA? Not necessarily. If your TFSA is your primary investment account, or a big part of your overall investments, you may need to hold non-Canadian stocks to have proper diversification. If it is a small part of your overall portfolio, you may be able to have a bias towards Canadian stocks in your TFSA, but that may or may not be the best investment strategy depending on the value and type of your other investment accounts. Canada is a small part of the global stock market and has little exposure to sectors like technology and health care, so foreign stocks help diversify and can increase risk-adjusted returns.
Can you avoid foreign withholding tax by holding Canadian mutual funds or exchange traded funds (ETFs) in your TFSA, Tawheeda? Unfortunately, no. They, too, are subject to withholding tax on foreign dividend income, so even though you will not see withholding tax on your TFSA statement, the mutual fund or ETF itself would have withholding tax before receiving dividends from foreign stocks.
TFSA withdrawals are always tax-free. However, if you overcontribute to your TFSA, in excess of your TFSA limit, you may be subject to a monthly penalty tax, plus interest. A similar penalty applies if you overcontribute to your registered retirement savings plan (RRSP).
Income Tax Guide for Canadians
Deadlines, tax tips and more
When do you pay tax on an RRSP?
When you buy and sell for a profit in your RRSP, the proceeds are not generally subject to tax. RRSPs are generally only taxable when you make withdrawals. Unlike your TFSA, business income treatment does not generally apply to day trading in your RRSP. One exception could be if you are trading non-qualified investments in your RRSP, which would be uncommon. Qualified RRSP investments include things like cash, guaranteed investment certifications (GICs), bonds, qualifying mortgages, stocks, mutual funds, ETFs, warrants and options, annuity contracts, gold and silver, and certain small business investments.
How are dividends taxed in an RRSP?
U.S. dividends may or may not have withholding tax in your RRSP, Tawheeda. If you own U.S. stocks directly in your RRSP, there will be no withholding tax. If you own U.S. stocks through a U.S. ETF, you will not have withholding tax, either. However, if you own U.S. stocks indirectly through a mutual fund or an ETF listed on a Canadian stock exchange, that mutual fund or ETF will be subject to U.S. withholding tax on any dividends before it receives them, even though you will not notice any withholding tax on the dividends or distributions you personally receive from the fund. You see, a Canadian mutual fund or ETF is itself considered a non-resident of the U.S., subject to 15% withholding tax. The account the fund is held in does not matter. The withholding tax will still apply.
I disagree strongly with this model of how RRSPs work … “Withdrawals are fully taxable, so … income and capital gains become taxable income.”
That leads to all kinds or wrong choices (like holding normally fully-taxed interest income assets in an RRSP by preference). ……. INSTEAD use a different conceptual model – the one that explains the facts that everyone agrees with … a) that TFSA profits are never taxed, and b) that $outcomes from TFSA and RRSP are always equal when tax rates don’t change between cont and draws. Those two statements could not be correct if RRSP profits were taxed………….INSTEAD explain the RRSP with a model that splits the account in two: 1) You with your after-tax savings, and 2) CRA with the contribution’s tax refund/reduction). You invest CRA’s funds alongside your own. Neither of your profits gets taxed. At withdrawal, CRA takes back its original funding plus its tax-free profits. You are left with YOUR $after-tax-savings plus your NEVER-TAXED profits. ……… A CHANGE IN TAX RATES between contribution and withdrawal does not change all that. It creates a separate benefit factor = (the $draw) multiplied by (the difference in effective tax %rates between cont and draw).