5 Best ETFs for TFSA (Feb 2023): Invest Tax-Free

The Tax-Free Savings Account (TFSA) is one of the most versatile accounts you can use for your investments in Canada.

The TFSA is different from a non-registered investment account because there is a limit to the amount of money that can be added to your TFSA.

Although investment growth within the account is tax-free here in Canada, it is extremely important to understand the concept of foreign withholding tax, which we’ll get into below.

We’ll cover the best ETFs for TFSAs, and outline some of their features below.

Foreign Withholding Tax: What Type of Investment is best for TFSA?

Most countries, including the US, apply foreign withholding taxes to certain income streams. In the US, this applies mainly to dividends from investments. US bonds and other fixed-income instruments are generally exempt from foreign withholding tax.

In the US, the first level of foreign withholding tax is applied to Canadian investors that are buying US-listed stock ETFs. Taxes are withheld once dividends are paid by a US-listed ETF to a Canadian investor.

If a Canadian-listed ETF exists that invests into a US-listed ETF, foreign withholding tax again becomes a problem. The Canadian-listed ETF will pay out a dividend net of the US tax.

In theory, you would be paying zero Canadian taxes on gains within your TFSA, but your dividends would be reduced significantly by the US foreign withholding tax.

When investing globally, it is critical to check what each country’s tax laws are. Some countries may apply a foreign withholding tax to fixed-income investments.

Since you are likely concerned with your after-tax rate of return, it is best to consider which accounts to place ETFs into for tax efficiency. Here are some ETF ideas that generally work well within a TFSA include:

  • Fixed-Income that is free of foreign withholding tax
  • Canadian dividend-paying ETFs
  • Non-dividend-paying US stocks
  • High-growth investment ideas

Coupons from bonds are usually the least tax-efficient income source, meaning that you save the most in taxes by holding fixed income in your TFSA.

US stocks that don’t pay a dividend are great candidates because there is no foreign withholding tax on capital gains.

High-growth investment ideas are also an option because you would be saving the most in taxes over a long period of time.

Best ETFs for TFSAs

1. TD Canadian Aggregate Bond Index ETF

TD Logo
  • Ticker: TDB.TO
  • Inception Date: March 22, 2016
  • Assets under Management: $483.82 million
  • Management Expense Ratio: 0.09%
  • Listed on: Toronto Stock Exchange
  • Annualized Yield: 3.00%
  • Stock Price: $13.18
  • YTD Return: 3.19%

TDB is a passive Canadian fixed-income index ETF. The ETF tracks the performance of the broad Canadian fixed-income market. It aims to replicate the Solactive Broad Canadian Bond Universe TR Index.

Since TDB is a bond index ETF, it pays a great annualized yield on a monthly basis. This is fairly common for fixed-income mutual funds and ETFs. The ETF is large in terms of assets and has a very low MER.

Canadian bond ETFs like TDB can be used in a fixed-income portfolio for more risk-averse investors, or in combination with stock ETFs to create a balanced portfolio.

Bond income in Canada is taxed at your marginal tax rate, making it extremely tax-inefficient. Due to the TFSA’s ability to eliminate taxes, your bond portfolio can avoid paying the highest possible investment tax rate.

2. Vanguard FTSE Canadian High Dividend Yield Index ETF

Vanguard Logo Transparent
  • Ticker: VDY.TO
  • Inception Date: November 2, 2012
  • Assets under Management: $1.74 billion
  • Management Expense Ratio: 0.21%
  • Listed on: Toronto Stock Exchange
  • Annualized Yield: 3.83%
  • Stock Price: $43.88
  • YTD Return: 6.65%

VDY is an index ETF offered by Vanguard. The ETF offers exposure to Canadian stocks paying a high dividend yield. It passively tracks the FTSE Canada High Dividend Yield Index.

VDY pays an amazing dividend yield through its focus on high dividend-payers. The ETF is very large in size and comes with a significantly higher MER than the index ETFs offered by TD.

The reason why you would want to include high dividend companies in your TFSA is that dividends are taxed less favourably than capital gains.

The most tax-efficient investments (those offering capital gains) should be kept outside of your TFSA, while dividend-paying companies should be held within.

Since VDY invests in Canadian stocks, foreign withholding tax is not an issue here.

3. TD Canadian Equity Index ETF

TD Logo
  • Ticker: TTP.TO
  • Inception Date: March 22, 2016
  • Assets under Management: $1.05 billion
  • Management Expense Ratio: 0.05%
  • Listed on: Toronto Stock Exchange
  • Annualized Yield: 2.00%
  • Stock Price: $23.59
  • YTD Return: 6.96%

TTP is another index ETF offered by TD. The ETF looks to replicate the performance of the broad Canadian stock market. It passively follows the Solactive Canada Broad Market Index.

TTP has a good dividend yield which reflects the sector bias of the Canadian stock market. You will be heavily concentrated in sectors such as financials, materials, and energy. The fund has quarterly distributions.

The ETF is also very large in size and has a very low MER.

TTP’s good dividend yield allows you to access an income stream while also having equity-like growth potential. Since it invests entirely within Canada, there are no issues involving foreign withholding taxes when holding TTP in your TFSA.

4. iShares S&P/TSX Canadian Dividend Aristocrats Index ETF

ishares logo
  • Ticker: CDZ.TO
  • Inception Date: September 8, 2006
  • Assets under Management: $1 billion
  • Management Expense Ratio: 0.66%
  • Listed on: Toronto Stock Exchange
  • Annualized Yield: 3.42%
  • Stock Price: $31.38
  • YTD Return: 6.11%

CDZ is another Canadian high-dividend ETF that is a part of Blackrock’s iShares lineup. The ETF focuses on high-quality Canadian dividend-paying companies. It passively follows the S&P/TSX Canadian Dividend Aristocrats Index.

CDZ has a great dividend yield which is paid out monthly. It is heavily concentrated in the financials, energy, and utility sectors. The ETF is very large in size and comes with a relatively high MER for a passive Canadian equity ETF.

The TFSA will again allow you to benefit from a high dividend yield from CDZ without paying taxes. Since the ETF only invests in Canada, there are no foreign withholding tax implications.

5. Fidelity Canadian High Dividend Index ETF

Fidelity Logo
  • Ticker: FCCD.TO
  • Inception Date: September 13, 2018
  • Assets under Management: $199.61 million
  • Management Expense Ratio: 0.35%
  • Listed on: Toronto Stock Exchange
  • Annualized Yield: 3.92%
  • Stock Price: $28.45
  • YTD Return: 6.13%

FCCD is a final Canadian high-dividend ETF from Fidelity Investments. The ETF also focuses on high-quality Canadian dividend-paying companies. It passively follows the Fidelity Canada Canadian High Dividend Index.

FCCD pays a slightly lower dividend yield than its high-dividend peers on our list. These distributions are paid out to investors on a monthly basis. FCCD is smaller than the other ETFs on our list (but still a large ETF), and has a fairly recent inception date.

The ETF’s MER is higher than VDY’s but lower than CDZ’s.

The TFSA will once again allow you to benefit from a high dividend yield from FCCD without worrying about taxes. The ETF only invests in Canada, so there are no foreign tax implications.

Are ETFs Good for TFSA?

You may be wondering whether to invest through an ETF or by purchasing individual stocks or bonds within your TFSA.

The key benefit of an ETF is that it allows you to diversify your investment with a one-ticket solution. Choosing a few stocks or bonds will likely cause your portfolio to be under-diversified.

A potential drawback of using ETFs in your TFSA is that the funds themselves are not managed to be TFSA-specific. The individual fund managers are investing according to their specific investment mandates.

Any TFSA-specific issues that can occur with an ETF, like foreign withholding taxes, are harder to control through an ETF.

If you are able to build a well-diversified stock and/or bond portfolio that matches your goals and risk profile, you will likely have better control over your investments. Individual stock and bond investments will allow you to avoid foreign withholding taxes more easily.

Keep in mind that Canadian ETFs which invest exclusively in Canadian stocks or bonds usually do a good job of sticking to their mandate. This means that any foreign withholding tax issues should be minimal if they are purchased in your TFSA.

How to Buy the Best ETFs for TFSAs

The cheapest way to buy ETFs is from discount brokers. My top choices in Canada are:

Readers Choice
Qtrade
  • 105 commission-free ETFs to buy and sell
  • Excellent customer service
  • Top-notch market research tools
  • Easy-to-use and stable platform 
Low Fees
Wealthsimple Trade
  • Stock and ETF buys and sells have $0 trading fees
  • Desktop and mobile trading
  • Reputable fintech company
  • Fractional shares available
Well-Rounded
Questrade
  • ETF buys have $0 trading fees
  • Excellent market research tools
  • Most types of registered accounts available

To learn more, check out my full breakdown of the best trading platforms in Canada.

Conclusion

Best ETFs for TFSA

While TFSAs protect you from Canadian taxes, foreign withholding taxes can always significantly reduce your investment returns. It is critical to be mindful of what ETFs are held within your TFSA to make sure your after-tax returns are optimized.

Foreign withholding taxes are only one thing to consider when it comes to your TFSA. Make sure you thoroughly understand how a TFSA works to avoid any unnecessary problems down the road.

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Author Bio - Christopher Liew is a CFA Charterholder with 11 years of finance experience and the creator of Wealthawesome.com. Read about how he quit his 6-figure salary career to travel the world here.

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