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Topic: How To Invest

Investor Toolkit: Make the most of your tax free savings account (TFSA)

Tax Shelters

Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a beginning or experienced investor, these weekly updates are designed to give you specific investment tips and stock market advice. Each Investor Toolkit update gives you a fundamental piece of investment advice, and shows you how you can put it into practice right away.

Today’s tip: “There are three ways you can ensure that you get the maximum profit, and tax benefit, from your tax free savings account.”

The federal government first made the tax free savings account (TFSA) available to investors in January 2009. These accounts let you earn investment income — including interest, dividends and capital gains — tax free. You could contribute $5,000 in 2009 to start your tax free savings account.

Every year until 2013, you could contribute an additional $5,000 to your tax free savings account. If you contribute less than the maximum to your TFSA in any given year, you can carry the difference forward. That means your TFSA contributions for 2009 and 2010 totalled $10,000, rising to $15,000 in 2011, $20,000 in 2012 and so on.

As of January 1, 2013 the annual contribution limit increased to $5,500. It remains at $5,500 for 2015. That means that if you haven’t contributed yet (and were 18 years or older in 2009) you can now contribute up to $36,500.

Tax-free savings accounts let you earn investment income — including interest, dividends and capital gains — tax free. But unlike registered retirement savings plans (RRSPs), contributions to TFSAs are not tax deductible. However, withdrawals from a TFSA are not taxed.

Here are three tips you can use to make sure you’re getting the most profit — and tax benefits —from your TFSA:

  1. Avoid putting higher-risk investments in your TFSA: Holding higher-risk stocks in your TFSA is a poor investment strategy. That’s because high-risk stocks come with a greater risk of loss. If you lose money in a TFSA, you lose both the money and the tax-deduction value of the loss. (Outside your TFSA, you can use capital losses to offset taxable capital gains.)

    You’ll also lose the main advantage of a TFSA: sheltering gains from tax. You won’t have gains to shelter if the value of your investments falls.

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  3. Your current income can help you decide between your TFSA and your RRSP: If funds are limited, you may need to choose between TFSA and RRSP contributions.

    RRSPs may be the better choice in years of high income, since RRSP contributions are deductible from your taxable income. In years of low or no income — such as when you’re in school, beginning your career or between jobs — TFSAs may be the better choice.

    Moreover, investing in a TFSA in low-income years will provide a real benefit in retirement. When you’re retired, you can draw down your TFSA first, then begin making taxable RRSP withdrawals.

  4. Your TFSA is a good place to hold exchange-traded funds (ETFs): Even though the limit is now $36,500, it’s still difficult to build a diversified portfolio within your TFSA. Instead, look to exchange-traded funds for TFSA investing.

    You could pick from the carefully selected ETFs we recommend in our Canadian Wealth Advisor newsletter’s ETF Portfolio. It’s one of three portfolios the newsletter offers to conservative and income-seeking investors (the other two are the Safety-Conscious Stock Portfolio and the Safety-Conscious Income Trust Portfolio). We continually monitor and update all three portfolios.

    Over the years, as the value of your TFSA increases, you could switch to a portfolio of conservative, mostly dividend-paying stocks spread out across the five main economic sectors (Manufacturing & Industry, Resources, Finance, Utilities and Consumer).


    • Thanks for the comment Neil…but if it is in your TFSA you don’t pay tax at all, so you don’t need the benefit of the Canadian dividend tax credit. D.T.

  • pierre 

    I Believe you have forgetten one important feature of this new tax advantegeous account, the fact that you can contribute by tranferring in securities that you already own in your taxable account. Granted that this strategy will not make you richer since your’e not investing new cash but It permits you to diminish the income payable in your taxable account. One careful note: If you wish to follow this route be sûre to tranfer securities on which you do not have a large unrealised capital gain since transféring such securities will deemed to be a sell transaction créatiing a taxable capital gain. On the other hand transfering a security on which you are loosing money will not create a tax déductible capital loss. We do not live in a perfect world.

  • If you buy US stocks for your TFSA you don’t get the benefit of tax free dividends as there is a 15% withholding tax at source. However what about capital gains on US stocks. The CRA would not tax them but would you have to report the gain to the US Tax man? Does the Can/US tax treaty deal with this?

  • Perhaps a person does not want the dividend gross up because that affects the taxable income and that could put you over the amount for claw back, it could affect your age deduction. The dividend gross up is calculated later in the tax form so putting dividends in the TFSA is perfect for some people.

    Also do not draw on your TFSA first in retirement. That is old school thought. What you want to do is this: draw down the RRSP as soon as possible so there is less money in the RRSP when you are 71/72 and must take out 7.38 percent the first year after reaching 71. That % goes up every year. So at 65 say, take out money so the total is not over 39 or 40 grand. Don’t forget you get OAS AND CPP so the amount you need to take out of your RRSP will be be the difference between your government cheques and 39/40 thousand dollars. If you need more than 39/40 to live then take some from the TFSA or investment account. If you have a spouse who worked and need 55,000 a year to live this amount can be accomplished simply by OAS and CPP times 2 plus the money needed from the RRSP to reach 39/40 thousand dollars each. This means that by the time you reach 71/72 and you are forced to withdraw 7.38%. This amount will be less because you have drawn down the RRSP. So why, 39/40 thousand? Ontario for instance has a change in tax rate at 39/40 and the federal government has a tax rate change at about 43/44 thousand.

    It’s better to pay low taxes at 65 than to pay high taxes at 71/72. Remember this amount will grow between the years of 65 and 71/72. So pull out as much as you need as said above.

  • Another tip – If you have interest paying investments in your non-registered account, transfer them to your TFSA. Unlike dividends and capital gains, there is no tax advantage to interest income.

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