New Year, New TFSA Room, Great Investment Ideas Here

Get excited savers!  A new year means more Tax Free Savings Account (TFSA) contribution room.  Here are a few facts about the TFSA and how you can benefit from this magical account.

TFSA 101

The Tax-Free Savings Account (TFSA) is a flexible, registered, general-purpose savings account* that allows Canadians to earn tax-free investment income.  The TFSA complements existing registered savings plans like the Registered Retirement Savings Plan (RRSP) and the Registered Education Savings Plan (RESP).

How the TFSA works:

  • As of January 1, 2013, Canadian residents, age 18 and older, can contribute up to $5,500 annually to a TFSA. This was a hike from the annual contribution limit of $5,000 for 2009 through 2012.
  • Investment income earned in a TFSA is tax-free.
  • Withdrawals from a TFSA are tax-free.
  • Unused TFSA contribution room is carried forward and accumulates in future years – hence, Happy New Year!
  • Full amount withdrawals can be put back into the TFSA in future years. Re-contributing in the same year may result in an over-contribution amount which would be subject to a penalty tax.
  • Contributions are not tax-deductible.
  • Neither income earned within a TFSA nor withdrawals from it affect eligibility for federal income-tested benefits and credits, such as Old Age Security, the Guaranteed Income Supplement, and the Canada Child Tax Benefit.
  • Funds can be given to a spouse or common-law partner for them to invest in their TFSA.

This is MUCH more than a general-purpose savings account*

The main advantage of a TFSA:  tax-free growth and tax-free income earned inside the TFSA.  So let’s look at some great investments ideas that could help you out, far beyond general-purpose savings.

1. Canadian Dividend Paying Stocks

Canadian dividend-paying stocks receive favourable tax treatment from our government; they are eligible for the Canadian dividend tax credit if left unregistered (outside TFSA and RRSP accounts).  But we are talking about the TFSA right?  We are, so Canadian dividend paying stocks will lose the dividend tax credit inside the TFSA but you’re still getting tax free dividend income inside the account for as long as those companies pay dividends.  It’s not inconceivable that an investor who has maxed out their TFSA every year since inception with some selected blue-chip Canadian dividend paying stocks could have a TFSA value close to $50,000 by now, churning out tax-free dividends.

2. Canadian Real Estate Investment Trusts (REITs)

Canadian REITs are companies that invest in real estate assets and distribute their income (primarily from rent) to shareholders, usually in the form of dividends, return of capital, and income. While it depends on the REIT, if the REIT distributes a portion of their income as return of capital, interest, capital gains or dividends, each portion will be taxed accordingly.  Keeping REITs inside a TFSA avoids this tax complication.  Many Canadian REITs are yielding more than 4% right now and you could expect (although nothing is ever guaranteed with any investment) some capital appreciation over time as well.

3. Canadian Exchange Traded Funds (ETFs)

An Exchange Traded Fund (ETF) is an investment fund traded on stock exchanges, much like stocks. An ETF holds assets such as stocks, commodities, or bonds, and trades close to its net asset value over the course of the trading day. Most ETFs track an index, such as a stock index or bond index. An index is a group of stocks or bonds used to measure the performance of a particular market – such as the S&P 500 stock index – you’ve probably heard of that one.  Not all indexes are created equal though.

So what are the benefits of ETFs, specifically those that track a broad market equity index?  Here are a few:

  • Low-cost
  • Diversification
  • Index-like returns
  • Income in the form of distributions
  • Easy to buy and hold using your discount brokerage account.

It’s not inconceivable that an investor who has maxed out their TFSA every year since inception with ETF XIU or XIC, wouldn’t be far from a portfolio value of $50,000 by now without any stock selection or headaches in doing so.   FYI:  The 5-year returns of XIU and XIC at the time of this post are both just over 7%.

Honourable mention goes to…

You might already know this but it’s worth mentioning there are 15% withholding taxes on U.S. stock dividends paid inside a TFSA.  You can’t recover these withholding taxes.  However, what about British stocks traded on the New York Stock Exchange (British American Depositary Receipts (ADRs))? (Note:  an ADR is a stock that trades in the United States but represents a specified number of shares in a foreign corporation. ADRs are bought and sold on American markets just like regular stocks; issued by a bank or brokerage). For many British ADRs there are no withholding taxes charged inside the TFSA.

The Best Bet

Most investors are best to avoid any stock market speculation and simply invest in low-cost indexed funds for the long-run.  My suggestion is to consider your TFSA much more than a general-purpose savings account.  Your future self in retirement will thank you.

Do you consider your TFSA as a savings account or a retirement account?  Share your story in a comment.

26 Responses to "New Year, New TFSA Room, Great Investment Ideas Here"

  1. Great post! Mark.

    TFSA is my favorite investment tool ever. I personally like it a lot more than RRSP. It is relatively simple to utilize and provide exceptional benefits of ignoring tax consequences and complications of interest, capital gains as well as dividend.


  2. Thanks for the article. My confusion still about usa witholding taxes. I have maxed my TFSA and invested in index funds, equally distributed in Usa equity, Canadian equity, international equity and canadian bonds. So based on the article The usa and international equity part of my portfolio strategically wrong due to witholding taxes. Not sure If I understood your suggestions correctly

    1. Using your TFSA with indexed funds is a great idea. I suspect this is the best decision most investors can make. I need to do more of that myself 🙂

      Using your TFSA to hold US and/or international equities isn’t wrong by any means, it just might not be tax efficient.

      Canadian index investors like you can get exposure to US and international equities these ways:
      1. via a US-listed ETF like VTI or VXUS
      2. via a Canadian-listed ETF that holds a US-listed ETF like VUN.
      3. via a Canadian-listed ETF or mutual fund that holds the equities directly.

      So…depending on the account, these products (ETFs) are treated differently. The experts on this stuff are Dan Bortolotti, who has written extensively on this subject, and Justin Bender:

      It’s a great paper and DIY investors should keep it handy for many great reasons.

      I hope this information helps!

  3. My wife has maxed out her TFSA since it began however I have not as I have plenty of room in my RRSP to catch up on but I still contribute every month. I think at this point since our mortgage is paid and we have no debt and just over 25 years until retirement (unless we retire early) the TFSA is more like a retirement fund for us. We have no plans to pull the money out as we have more than enough cash in the bank for emergency savings. It’s certainly something not to miss out on investing in if someone has the cash to do so.
    What do you consider your TFSA a savings or retirement fund Mark?

    1. Maxed out TFSAs are great, very well done!

      I have no short-term plans to withdraw funds from our TFSAs, so I consider them a retirement account for that reason Mr. CBB.

      Thanks for your comment and keep up the great work, including no debt.

  4. I actually have 2 TFSA accounts. 1 with just a simple high interest savings account (for emergencies / some shorter term savings [ie; new deck]) and 1 with an all equities low-cost mutual fund (for retirement). I do not have an RRSP and have no plans to get one for a while.

    Reasoning behind this is that I have a good size emergency fund and the TFSA account reminds me not touch it for anything not actually an emergency, unlike a regular savings account that I don’t have to worry about contribution room.

    I use TFSA over RRSP for my retirement savings as I’m in the lowest tax bracket. Yes, I know I can carry forward my RRSP tax credits, but I figure why bother? Let’s say something crazy happens and I never hit the next tax bracket…. I now get full CPP and OAS by investing in the TFSA instead of the RRSP. That’s what made sense to me. So between my 2 TFSA’s I do the max contribution each year. Everything after that goes straight onto the mortgage to get that paid off (down to a total ammoritization of 16 years total already! And that’s if I don’t continue to increase the payments anymore!)

    Oh, and I should mention the retirement TFSA is invested in an all equities fund because I am 21 years old. I wouldn’t say I have a very high risk tolerance, but I know time is on my side for retirement and I have plenty of time to recover from any huge downswing in the investment. And I do have a plan to incorporate bonds/reits/etc at different percentages at certain ages. But for the time being, it can stay in all equities.

  5. I using it as a long term, tax free, investment account before I’m required to also use my non reg investment account.
    I have my LoC in case of emergency and can redirect dividend, according to the situation.
    Since I will not retire at 67 I have no use of a RRSP.

    1. We sound similar, using TFSA for an investment account. I have an LOC for emergency fund and we also have some savings as well. I hope we never need to use either. I suspect, if our financial plan works out, we’ll draw down our RRSPs in our 50s.

  6. So any income earned on any and all investments in a TFSA is tax free, except for dividends (US and some other countries), correct? And for American, it’s 15% of dividends only, the rest (capital gains, etc) is free and clear?

    I ask as I have equal shares in TD E-Series at TD in US, INTL and CDN. Obviously everything in the CDN (and CDN BND) is all mine (minus MER). If my assumption is correct, the US one is all mine, minus 15% tax on dividends only? And the INTL one might have some taxes involved, depending on where they are (the companies/stocks held within).

    The reason I ask is, I’m considering my options and not sure which way to go.

    I could keep my e-series and just keep topping up.
    I could save up some money and go to Quest Trade ($5k balance to avoid quarterly fees) and buy RRSP US ETF and sell the TFSA US E-series and use it to buy canadian blue chip stocks and/or top up E-series CDN and CDN BND or buy CDN ETF.
    Or any other form of options.

    From what I can tell, Tangerine and E-Series are pretty decent, but ETF is better for lower MER once you have the capital to cushion for purchases (although with QT it’s zero to buy ETFs).

    You mentioned in this post ETFs that hold US stocks for US exposure, but trade on the TSX like those Vanguards. Would those then go into a TFSA because it’s Canadian or does it still fall under US held companies and therefore still subject to with holding tax?

    1. Thanks for all your questions Greg.

      As you are learning by now, different assets in different accounts are treated differently from a tax perspective.

      So, when it comes to foreign investments because you are a Canadian using a Canadian “tax-free” account, everything really isn’t tax-free. Like you have suggested…

      1) U.S. stocks or U.S.-listed ETFs held within RESP or TFSA = pay 15% withholding taxes. You can’t get that money back.
      2) U.S. stocks or U.S.-listed ETFs held within non-registered accounts = pay 15% withholding taxes (which is recoverable).

      Everything else earned from these U.S. stocks and U.S.-listed ETFs inside your TFSA is “free and clear” as you put it, as long as you own a US-dollar TFSA of course. Because you are buying U.S. assets listed in the U.S., you have to worry about foreign exchange!

      When it comes to withholding taxes I can appreciate things are tricky. Here is a stellar white paper written about it at the bottom of my indexing page:

      Yes, Tangerine and TD e-Series are quite decent for just starting out but you are correct, the lower the MER the better for the longer I believe when your account values get higher. If you can keep your money management fees low and trading costs low for as long as possible; this is a winning strategy.


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