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I have a TFSA that I tend to max out every year. I would like to invest this money into stocks that pay me out dividends on a regular basis.

I asked a previous question about the tax implications in my province, and was happy with the results. I would like to know though, if I can use money from my TFSA, and have the dividends paid out tax free, as in without requiring me to pay more tax on it every year.

If this is possible, how can I set this up?

  • What kind of stocks do you intend to hold in the TFSA? Canadian stocks only, or, say, U.S. stocks, too? You need to know that dividend income from outside of Canada won't get the same tax treatment. Other jurisdictions may deduct withholding taxes from your dividend income. – Chris W. Rea Jul 17 '14 at 1:47
  • Right now, just Canadian stocks – Canadian Luke REINSTATE MONICA Jul 17 '14 at 4:06
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You do not have to pay tax on any earnings inside a TFSA. Quoting Wikipedia's article, "Investment income, including capital gains and dividends, earned in a TFSA is not taxed, even when withdrawn." This is backed up by the official TFSA government site, http://www.tfsa.gc.ca/, which states, "Investment income earned in a TFSA is tax-free."

This makes the TFSA an appropriate vehicle to store investments which produce dividends. For example, if you invest $5500 and receive a total of $500 in dividends this year, you will not pay tax on that $500, either in this tax year or even subsequently, when you withdraw money out of your TFSA.

Of course, TFSAs aren't meant to be used for regular withdrawals. If you are planning on investing $5500 this year and withdrawing the dividends, I'd urge you to be careful and consider if this is actually the best sort of savings vehicle for you. But that's really just a general warning, nothing specific to dividends. It is possible to do this. Indeed, withdrawing $500 in dividends this year will increase your available contribution room in the next tax year (not in this tax year).

For example, you contribute $5500 at the beginning of this year. By the end of November, you have accumulated $500 in dividends. You withdraw these in December. In the following tax year, you can recontribute this $500 in addition to the standard $5500 contribution room. So, you could contribute $6000. Just be careful with your calculations; I messed mine up and ended up paying a rather substantial penalty for my overcontribution.

  • Thanks Chris. Let's assume I just want the dividends to stay in the investments to purchase more stocks as time goes on. Is it enough to give my TFSA bank details to the transfer agent and say "earnings are tax free from this account"? – Canadian Luke REINSTATE MONICA Jul 16 '14 at 21:56
  • The way MY TFSA account (at TD Bank, it's similar at Tangerine but simpler) works is that I have some mutual funds (though could be stocks or ETFs), plus a little bit of cash. Any dividends increase the cash value. I can then use that to buy more, or just leave it as cash. As the TFSA account holds the cash and the stocks/mutual funds, there's nothing for me to declare. Because it's inside an account designated as a TFSA, the bank already knows earnings are tax free. – ChrisInEdmonton Jul 16 '14 at 22:00
  • Oh... I should probably mention, I don't use my bank for investing... – Canadian Luke REINSTATE MONICA Jul 16 '14 at 22:01
  • I expect a non-bank would work similarly to how TD Bank (actually, TD Waterhouse) does it; TFSA with whatever holdings you want, plus cash. You'll have a separate account for RRSP and a separate account for regular (i.e. non-RRSP, non-TFSA) investments. – ChrisInEdmonton Jul 16 '14 at 22:03
  • @CanadianLuke What do you mean by "give my TFSA bank details to the transfer agent"? If you mean to invest in individual dividend stocks via each corporation's dividend reinvestment plan (DRIP), such stocks aren't held inside of a TFSA, but rather directly in your name, and the income would be taxable. Generally, when you buy stocks within a self-directed TFSA, your broker holds them for you, in street name. As such, you wouldn't be participating directly in a corporation's DRIP. Any TFSA "DRIP" would likely be a synthetic one. – Chris W. Rea Jul 17 '14 at 1:52
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Given you other question and your resulting marginal tax rate, you may want to optimize where you hold each type of security. If you still plan to have a regular investment account, it's hard to beat the low tax rate of Canadian dividends.

In a TFSA, you won't pay tax on the dividend income, and you won't get a dividend tax credit either. For some people in BC this actually costs them money as they have negative marginal dividend tax rates. For you it seems to be 6%.

Contrast this with any other holding in your regular account, interest at full marginal rates, and cap gains at half that. Dividends still win in a regular account.

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