What should you put in your TFSA?

Happy New Year savers. A new year means more Tax Free Savings Account (TFSA) contribution room.  Here are some fast 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 Plans (RRSP) and the Registered Education Savings Plans (RESP).

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.

How the TFSA works:

  • Canadian residents, age 18 and older, could have contributed tens of thousands of dollars to date into their TFSA if they haven’t opened the account yet. If you want to see the actual amount to date please check out this post here including the current lifetime contribution limit:

Great things you can do with your TFSA

  • Growth and investment income earned inside the account is tax-free.
  • Withdrawals from a TFSA are tax-free.
  • 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.

Simply put, this account is great and for once, you should be thanking our government for this gift.

What should you put inside your TFSA?

I suppose the answer (as always) should depend on your financial plan and goals. Plans should probably come before products. That said, given you have your financial goals understood I personally believe equities should be inside the TFSA.  Sure you could use your TFSA for your cash emergency stash or holding a bunch of bonds or fixed income investments but I think most Canadians could benefit from long-term, tax-free, growth inside this account.  Heck, even for many retirees, they may want to consider equities.  Not convinced?   Here is what our new Finance Minister wrote in his recent book The Real Retirement:

  • Studies indicate government bond yields go through cycles lasting about 60 years: 30 years for the uptrend and 30 years on the other side.  If the theory holds true, yields have “virtually no room to move further downward, thus no capital gain opportunities remain”.
  • “Actuaries estimate that real returns on bonds over the next 25 years will average between 1 and 1.6 per cent depending upon the term of the bond”.

So, back to the question, what should you put in your TFSA? 

Consider these great options.

  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?  Although Canadian dividend paying stocks will lose the dividend tax credit inside the TFSA you’re still getting tax free dividend income inside the account for as long as those companies pay dividends.  Staples within my portfolio include Canadian banks, telecommunication companies and utilities inside the TFSA for the foreseeable future.

You may want to consider these dividend paying stocks built to last for your portfolio.

ETFs and dividend stocks built to last for your portfolio

  1. 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

You might already know from my blog, I’m a hybrid investor.  I invest in a number of dividend paying stocks for growing passive income and I also invest (more) using ETFs for better diversification. 

I think low-cost Canadian ETFs, like XIU, XIC, VCN, VCE, and a few others, those that track a broad index, are a great long-term fit for any TFSA.

You might also want to consider some all-in-one funds as well.

The Best all-in-one Exchange Traded Funds

  1. 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 have dropped significantly in price over the last year, which makes them an interesting buying point for those that like investing when there’s “blood in the streets”.

Be mindful, REITs are just a particular asset class on their own.

Consider how much real estate you should really own in your portfolio.

How much real estate should you have in your portfolio?

  1. British American Depositary Receipts (ADRs)

You might already know this but it’s worth mentioning, there are 15% withholding taxes on U.S. stock dividends paid inside a TFSA – this is why I did not list U.S. stocks or U.S. ETFs for your TFSA in this post.  If you’re going to own U.S. stocks or U.S.-listed ETFs, probably best to put them inside your RRSP.  However, British ADRs traded on the New York Stock Exchange have no dividend withholding taxes.

In the end, what you invest in is your decision and your responsibility.  If I had my choice, and I do, I’ll focus on Canadian content via some individual stocks and ETFs for my TFSA this year.  I’ll be taking the long view with my investments inside this account and I’ll avoid making any speculative plays with penny stocks or junior mining companies.  That’s my game plan, what’s yours?

What are your investments for the TFSA?

Additional reading:  How to diversify your investments using your Tax Free Savings Account here.

27 Responses to "What should you put in your TFSA?"

  1. Daniel:
    It’s my opinion that one should max out the TFSA before placing money in an RRSP. If one is in a position to put money into both, than it makes sense to keep US stocks in the RRSP and get the max compounding from your dividends,

  2. Dummy question probably but why is so bad to keep US stocks on a TFSA?

    I understand the 15% withholding but the rest is tax free compared to having US stocks in your RRSP account that will at least be taxed 20% at withdrawal depending on your province and annual income.

    I guess that all depends on when are you going to withdraw from the RRSP and by compounding interest on that money not yet taxed you will be ahead.

    Does this make sense?


    1. Thanks for reading Daniel, it’s not “so bad” as you say.

      The way I see it, if your tax rate in retirement is more than 15%, and it might be for most people, then it could very well make sense to keep U.S. stocks inside your USD TFSA.

      1. I agree, I’m just surprised that most blogs just suggest that RRSP is better for U.S. stocks compared to TFSA without mentioning that you will be taxed some day on those dividends anyway, and probably at a higher rate.

        1. Fair point Daniel. I think taxation is an issue when it comes to investing but I’m not sure it should be the first thing – meaning, best to get your asset allocation determined, your financial plan determined, etc. My hope is our tax rate in retirement will be below our current tax rate, and furthermore, I’m optimistic most of our income will be dividend income taxed at a low rate.

  3. This is a really great article but to clarify one point if you have to have been 18 in 2009 to have $46,500 in your TFSA. If you turned 18 in 2016 you only have $5,500 in contribution room!~

  4. Congrats on another nice article!

    The TFSA is really a must for all Canadians!

    That being said, I would also like to point out that some Canadian fiscal rules will change this year (fiscal year 2016) with the new liberal government. Depending on your situation, 2015 may be a good year to make a push in your RRSP.

    So, be sure to take into account these changes before you contribute to your 2015 RRSPs or TFSA as it may be your last chance to take advantage of some conservative tax measures.

    My initial analysis almost made me miss an opportunity to get an additional tax refund of 5% to 8%. I finally decided to maximize my RRSP contributions in 2015 and invested an extra $15K.

    For some of the details, have a look at my article here:
    Special RRSP Tax Considerations for 2015

    1. Thanks for writing. I just checked out your site. Nicely done! Starting in the 2016 tax year, yes, the Liberals will reduce the middle tax bracket from 22% to 20.5% (for taxable income between $45,282 and $90,563 in 2016). With a lower taxable income, that means the RRSP tax-generated refund for the 2016 tax year will be lower as well, something to keep in mind as investors still have an opportunity to contribute to the 2015 tax year via RRSP contributions.

      My wife and I already have monies sent to the RRSP automatically every month.

  5. Thank you for the article. It would be nice to see some different strategies here when it comes to TFSA.
    I was wondering if you could provide a few sample portfolio with allocations, especially if you are going to exclude US ETFs.
    For example, currently I have index mutual funds in TFSA, but considering changing to ETFs.
    What I have in mind is that
    60 % Canadian Bonds (XQB or VAB)
    20% Canadian Equity (XIC, or VCN),
    40 % international including USA and emerging market ( combination of XEE, XEF, VUN or VXC).
    Would appreciate your opinion on this. Thank you.

    1. Thanks for the comment Marcus. I can’t offer any personal advice on this site for many reasons but I think many Canadians could use their TFSA for CDN equities vs. bonds. That said, if some investors felt strongly about bonds, then either a GIC ladder or low-cost, short-term bond ETF like XSB or VAB would be good inside the TFSA.

      I don’t think there is anything wrong with indexed mutual funds inside the TFSA, there are some good products for that, as long as they are low-cost funds. Otherwise, higher fund fees will kill your portfolio value over time – just a sad mathematical fact.

      When it comes to international exposure, some of those funds you listed are very good ones: XEE, XEF, VUN or VXC. Just be mindful that a Canadian-listed ETF that holds US stocks/ETFs or international stocks/ETFs have withholding taxes charged to them that are not recoverable inside an RRSP or TFSA. These withholding taxes effectively double the MER.

      The way to get around this is by owning U.S. listed ETFs in your RRSP, not your TFSA.

      All the withholding taxes aside many investors would do well do construct a TFSA portfolio with some of the products you mentioned – because of the diversification they offer and lower-costs 🙂

    2. You can find below a summary of what I did for my TFSA over the past few years.

      Please keep in mind that the TFSA is only a portion of my portfolio and was used this way mostly for tax efficiency.

      I started with international equities, in TDB911 mutual fund as this allowed regular investments without comission fees (also, although the MER is higher than some ETFs, it holds the foreign stocks directly so the total foreign witholding tax is about 10% of distributions). I also added emerging market bonds ETF as well as canadian corporate bonds ETF.

      I then changed most of my TFSA holdings to publicly traded canadian MICs (AI, MKP, FC, TF, TZZ) for both high income and appreciation during a few years of canadian real estate boom… although this might not work as well for the next few years.

      I will probably convert part of my TFSA back to international equities, this time with ZEA by BMO or XEF by iShares. The vangaurd canada ETF is not really suitable for a TFSA as it holds the US ETF so you have 2 layers of witholding taxes.

      You could also choose to add a canadian railroad, a safe utility or bank, emerging market etf, etc.

  6. Put SOMETHING in there, the government is letting you hide income from them, so please take advantage of that fact.

    The Dividend point is a good one, yes, you are losing the preferable view of Dividend income in your TFSA, but that is because you aren’t paying ANY tax on it! Took me a while to figure that one out (I have a thick skull).

  7. As usual a great summary of the TFSA and what to invest within it. Personally I like #1. Just for clarification, a person just turning 18 would only be able to contribute $5,500 in 2016, not the $46,500.

    1. Correct cannew, the new 18-year old cannot use the allowance room for any of the previous years; it’s on a go-forward basis for the new 18-year-old (that’s my understanding).

  8. Before one examines what to hold in ones TFSA, one should be clear on what the TFSA is going to be used for. If one is saving short term for a down payment for a house they might have a different investment policy than one saving for retirement in 30 years.

    1. 100% agreed Lloyd hence my comment in the article about a “plan before products”. We’ve decided to use our TFSAs as a retirement account, although I know other people don’t agree with me on this. They have other goals for their TFSA, and nothing wrong with that. We feel the TFSA for CDN stocks and ETFs is part of our tailored plan.


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