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: “Here are three ways to make the most of 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.
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:
- 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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- 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.
- Your TFSA is a good place to hold exchange-traded funds (ETFs): Even though the limit is now $25,500, 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).
COMMENTS PLEASE—Share your investment knowledge and opinions with fellow TSINetwork.ca members
What kind of investments do you hold in a Tax Free Savings Account? Have you changed the type of investments you hold in your TFSA since you began the account? If so, why?
Note: This article was initially published on March 30, 2011. All contribution limits and figures have been updated.