And what are you going to put in your TFSA?
The tax-free savings account: what a humble name! Because the TFSA is really much more than a simple “savings account.”
Did you hear about the Toronto investor who amassed more than a million dollars in his TFSA? Pretty good for an account that has acontribution limit of $41,000 as of 2015… and really good for a “savings” account!
This spectacular case is currently under review by the Canada Revenue Agency, but it illustrates an undeniable fact: a TFSA can be a much more powerful tool than what we generally mean by a simple savings account. As long as it contains the right investment vehicles, of course.
A container for many different investments
To simplify their product offering, and because these accounts can be costly to administer, many financial institutions offer “simplified” TFSAs based on a single product. This might be short-term investments, for instance, or guaranteed investment certificates (GICs).
But a TFSA, like RRSP, RESP or RRIF, is actually a container that can hold different types of investments. In fact, the TFSA regulations allow the account to hold one or more of the following:
- mutual funds;
- securities listed on a designated stock exchange;
- guaranteed investment certificates (GICs);
- certain shares of small business corporations.
If you are a client of Services d’investissement FÉRIQUE, your TFSA can work equally well for your short-term needs ̶ using the FÉRIQUE Short-Term Income Fund, for example ̶ and your long-term plans ̶ using a diversified fund such as the FÉRIQUE Balanced Growth Fund, for example. In the first case, your money is invested in a vehicle with high liquidity and low volatility. In the second, you accept a higher level of volatility, but benefit from the potential for a higher return. In both cases, you enjoy significant advantages: your investment returns are tax sheltered* and, because your capital is in mutual funds, it is available to you at any time.
Some interesting possibilities
A TFSA that is invested in mutual funds probably won’t make you a millionaire in the next few years, but its advantage over a taxable account is obvious: your investment income, whether in the form of interest, dividends or capital gains, will never be taxed*.
As a general rule, it is in an investor’s interest to maximize the use of the TFSA and tax-deferred accounts (RRSP, RESP, RRIF), depending on his or her needs, before resorting to an investment account where the investment income would be taxable.
However, if you can afford to have an investment account as well, an interesting question arises: how should you divide your money between your TFSA and your taxable account? There is no one-size-fits-all answer, but here are two approaches that you might want to discuss with a member of our Advisory Service team:
- Use the TFSA mainly for your funds that are subject to the highest taxes – those that generate mainly interest and dividends, for instance – and leave the ones that generate mainly capital gains outside of the TFSA, since these already benefit from a tax advantage (only 50% of a capital gain is taxable);
- Use the TFSA mainly for your funds with the highest potential returns, since your tax saving will be even greater if these return are realized. On the other hand, you might not recover all of your contribution room if the returns have been negative by the time you withdraw the funds. For example, suppose an investor who had put $5,000 into a mutual fund within a TFSA decides to withdraw this investment, which is now worth just $2,000. Next year, his or her contribution limit won’t be increased by $5,000, but only by $2,000, since the limits are adjusted according to how much you withdraw.
While the second approach has the advantage of being simple, keep in mind that real life can sometimes be more complicated. For example, if you have allowable capital losses from prior years, it might be in your interest to realize capital gains outside of a TFSA. You could reduce your taxes by carrying your past losses forward and applying them against your current capital gains. Similarly, if you realize losses on investments outside of a TFSA, you could apply these against past capital gains and recover tax you have already paid.
As you can see, with the appropriate advice, a TFSA can really leverage wealth-creation when properly aligned with your plans, your goals and your personal situation. So why not think about turning your TFSA into a “TFIA”? A tax-free investment account!
Contact our Advisory Service to set up a strategy that is optimal for you:
514-788-6485 | 1-800-291-0337
You can also email the team at [email protected]; you'll receive an answer within 24 to 48 business hours.
* Some conditions apply. Investors must comply with TFSA rules.
For more information, please contact the Services d’investissement FÉRIQUE Advisory Service team.