What the withholding tax is
When a U.S. corporation pays a dividend to a Canadian resident, the payer withholds tax before the money reaches your account. Under the Canada-U.S. tax treaty the standard rate is 15 percent. The withheld amount goes to the U.S. government, not to the Canada Revenue Agency, and it is taken at source, so you simply receive less cash than the declared dividend.
Why a TFSA does not escape it
The treaty recognises retirement accounts such as the RRSP and exempts qualifying dividends on U.S. securities held directly in them. A TFSA is not covered by that exemption, so the 15 percent withholding applies and generally cannot be recovered. In a non-registered account the same tax is withheld, but you can usually claim a foreign tax credit on your Canadian return.
That is why many Canadians place U.S. stocks in an RRSP, Canadian dividend payers in a taxable account and growth-oriented holdings in a TFSA. The right mix depends on your income, contribution room and goals, so treat this overview as a starting point for research.
How the calculator estimates the drag
The S&P 500 pays a dividend yield that has been around one to two percent per year across long periods. Fifteen percent of that yield is a loss of roughly 0.15 to 0.30 percentage points per year. The calculator applies a flat 0.30 percentage point annual reduction, spread evenly across months, when the TFSA option and the S&P 500 are selected together.
That is a deliberately conservative simplification. Actual drag varies with the yield in each year, and it only applies when dividends are part of the return, so it is ignored in price-only mode and for assets that do not pay dividends such as gold.
Small number, big compounding
A drag of a third of a percent a year sounds trivial, but it compounds. Over a quarter century it can reduce the final balance by a few percent, and the effect grows with larger balances and longer horizons. The Key facts table uses whichever tax setting is selected, so switch between pre-tax and TFSA to compare the outcome for the same dates, and bump up the contributions to see how the gap scales.
It also helps to keep perspective. The withholding tax is a cost, but the tax-free growth and withdrawals inside a TFSA are worth much more for many investors than this friction.
Worked example in plain language
Imagine a U.S. company declares a dividend of one hundred dollars on shares you hold in a TFSA. Fifteen dollars is withheld before the payment arrives, so you receive eighty-five. If that dividend were reinvested, only eighty-five dollars would buy new shares. Repeat that every quarter for decades and the missing fifteen percent of each payout, along with the growth it would have earned, adds up.
In a non-registered account you would also receive the eighty-five dollars, but you may claim a foreign tax credit when you file, which offsets the Canadian tax otherwise owed on that income. The TFSA has no such offset, which is exactly why the drag is a real cost inside it.
Ways investors think about it
Some investors hold Canadian-listed ETFs that own U.S. stocks. These funds still suffer withholding at the fund level in every account type, and the cost is reflected in the ETF's returns. Others hold U.S.-listed ETFs in an RRSP for the treaty benefit, accepting currency conversion costs. Every approach has tradeoffs, and tax rules change, so verify current rules with the CRA or a qualified professional.