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Monday, December 22, 2014

Under the Hood of My TFSA

Posted by Tim Stobbs on October 7, 2013

During my last net worth update I commented on the fact my Tax Free Savings Account (TFSA) contributions are now maxed out which would mean I’ve contributed $25,500 in the last five years.  That account balance at that time was $33,100 or a total gain of $7600 or 30%.  The gains are big, but you have to keep in mind that my TFSA is my highest risk account.  Unlike a lot of people who just put their contributions in savings account (paying 1% return which is so tragic waste of this accounts potential I almost weep when I hear it), mine is all invested in individual stocks.

So why is a savings account is a tragic waste of potential?  Well let’s say you have maxed your TFSA ($25,500) in a high interest saving account at Royal Bank for a 1.1% yield.  That would be a big old $280.50 in interest per year.  Taxed at a marginal rate of 39%, you saved $109 in taxes. Not bad right?

In my TFSA, I buy stocks that mirror my bills since I’m interested in mature businesses that pay a good dividend or distribution.  My current holdings are: AQN, BCE, D.UN, NPI, and REI.UN.  In total these stocks pay me $1982 a year to hold them or if you compare that back to my contributions that is a 7.8% yield. That is a high yield, but like I said this is my high risk account, I would be insulted if I wasn’t being paid well for taking the risk.  Now just on the distributions (39% marginal tax rate) and dividends (17.9% marginal tax rate) I save about $505 per year on taxes.  Yet it gets better, I also save any capital gains taxes on anything I sell as well.

So it is safe to say I’m saving likely five times the taxes that people who have their TFSA in plain old savings accounts.  So what’s the deal?  Why do people use their valuable TFSA contribution room on just savings?  Well, the TFSA title tends to confuse some people, but the other thing is people focus too much on their marginal tax rates.  I’ve been asked several times why I’m putting dividend paying stocks in my TFSA since they think saving at your 39% marginal rate is better than a mere 17.9% for dividends.  The issue is how much yield are you saving the tax on, even if you ignore the income trusts in my TFSA I’m still saving $226 per year on tax on just the dividends.  I’ve got much more yield that even at a lower tax savings I’m still coming out ahead.

So the lesson for today is: don’t let the your marginal tax rate drive your investing behaviour, check the math when making investing decisions.  So what do you have your TFSA account invested in?

 

Comments

7 Responses to “Under the Hood of My TFSA”
  1. I do the same thing.

    Stocks (individual) are best held in TFSAs.
    Index funds are best held in RRSPs and Non-Registered accounts.

  2. I am new to investing, and am trying my hardest to smartly maximize my returns within my TFSA and RRSP. Can someone explain to me why individual stocks are best in TFSAs and index funds are best in RRSPs? Thanks.

  3. Jon_snow says:

    Love REITS in the TFSA. When real estate investment trust were hammered earlier this year, I went shopping. Artis REIT pays me 8% to own it. Like stealing really. Tim, like you said, those who hold cash in a TFSA are losing ground. My TFSA is valued at 29k right now, my wife’s 30k (I bought her a whack of BCE when it plummeted on the Verizon entry scare, and now it’s bouncing back nicely :) ).

    On a side note, bought a lot of POT when the Russian cartel situation blew up – it’s now marching higher in price. When good companies are hit, pounce people!!!!!

  4. Canuckguy says:

    Unfortunately in my case, I bought(in my TFSA) 500 shares of BCE being attracted by a good dividend rate just before the Verizon scare paying $45.25/share. I was not watching nor understanding the wireless news issues. Now I am worried the stock market might implode over the US debt ceiling crisis.

  5. Mara says:

    I didn’t know you could invest your TFS money in anything other than a bank’s savings account at minimal interest. How does one find out about other places to invest my TF dollars other than what the major banks advertise on their websites? Thank you kindly

  6. Roy says:

    You lost me here:

    “I’ve been asked several times why I’m putting dividend paying stocks in my TFSA since they think saving at your 39% marginal rate is better than a mere 17.9% for dividends. The issue is how much yield are you saving the tax on…”

    Can you work through that a little more slowly, please?

  7. Tim Stobbs says:

    @Alicia – It’s part personal preference, but one theory is your individual stocks stand a better odds of having one or two do really well. If that occurs in an RRSP you will have to pay tax on that money when you take it out, but in a TFSA there is no tax.

    @Chuckguy – My personal take on the US debt crisis is it won’t happen. Tea party may be nuts, but driving the world economy off a cliff likely won’t sit well with the moderates. I’m personally looking at buying during the slump.

    @Mara – All the major banks offer trading accounts which can be TFSA if you like. Otherwise I would look for low fees, so in that case Questrade is a good idea. I would caution Questrade don’t offer a ton of help if you are new to investing, so your local bank might be a good place to start if you are new to direct investing.

    @Roy – Ah, sorry I didn’t mean to make that confusing. My marginal tax rates on the ones listed above. So my point is saving 39% tax on a 1% return (interest income is taxed at your income marginal rate) is less than saving 17.9% on a 7.8% return (dividends have a different tax rate). Or if you use a default $10,000 investment to compare, it would be $10,000 x 0.01 x 0.39 = $39 tax saving is less than $10,000 x 0.078 x 0.179 = $139 tax savings. So my point is we tend to focus on just the tax rates, when your rate of return is just as important to your total tax savings. Hope that helped.

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