Introduction to TFSAs and Currency Exchange
As a Canadian resident, contributing to a Tax-Free Savings Account (TFSA) can be a great way to save for the future. However, when dealing with US funds, it’s essential to consider the exchange rate and its impact on your contributions. It can be easier to contribute to Canadian dollars to a TFSA or to use a buffer when estimating the conversion of the exchange trade from US to Canadian dollars if you contribute to US funds.
Understanding the Buffer
The exact amount of the buffer can be difficult to determine, as the currency can fluctuate from day to day. Your financial institution may also use an exchange rate that varies up to a few percent from the published rate. To be safe, you can consider building a 5% buffer and then ask your financial institution to confirm the contribution amount in Canadian dollars that will be reported to the Canada Revenue Agency (CRA). If you have a few dollars left over in your contribution limit, you can surpass it in Canadian dollars.
Responsibility for TFSA Contributions
Note that your financial institution does not have any responsibility for tracking or confirming your available TFSA space. It is ultimately up to you to ensure that you do not overcontribute. If you withdraw from a TFSA to make a contribution to another TFSA immediately, you will not get this contribution room back immediately. TFSA withdrawals affect your TFSA room the next January 1, whereby the net withdrawals for the year are attributed to your TFSA room for the following year. If you repeat this process too quickly, you may be subject to a 1% penalty tax.
Foreign Withholding Tax and TFSAs
If you have US securities or other foreign investments in your TFSA, the non-resident withholding tax generally applies. The financial institution is responsible for withholding the tax from dividends and distributions before they reach your account. The source tax is your final tax obligation to a foreign tax authority. Therefore, there are no tax obligations for a Canadian resident who is not a US citizen if you buy securities in your TFSA.
Alternatives to Buying US Shares
A diversified portfolio should include US and foreign stocks to supplement the Canadian stock market. On this basis, using a US TFSA can be a good investment strategy. You can also examine alternatives to buying US shares in US dollars, such as CDRs or US equity ETFs that are listed on the Toronto exchange. If you contribute US dollars directly to your TFSA, simply make sure that the contribution amount in Canadian dollars is not transferred to an overcontribution position based on the current exchange rate.
Conclusion
In conclusion, contributing to a TFSA can be a great way to save for the future, but it’s essential to consider the exchange rate and its impact on your contributions. By building a buffer and understanding your responsibility for tracking your TFSA contributions, you can avoid overcontribution and penalty taxes. Additionally, considering alternatives to buying US shares and understanding foreign withholding tax can help you make informed investment decisions. By taking the time to understand these factors, you can make the most of your TFSA and achieve your long-term financial goals.