Andrew has an MBA and has been writing for The Motley Fool Canada since 2014. As a contrarian investor, Andrew seeks out dividend opportunities the market is missing. He is a big fan of harnessing the power of compounding to grow a portfolio for retirement.
Latest posts by Andrew Walker (see all)
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TFSA Passive Income: Is Fortis Stock a Buy Now? - February 29, 2024
The government created the TFSA in 2009 to give Canadians a new vehicle for saving money for the future.
TFSA 101
Since its inception, the TFSA contribution limit has increased each year and is now as high as $69,500. The TFSA limit increased by $6,000 in 2020.
The TFSA limit hike for 2021 will be at least $6,000. The CRA raises the size of the annual increase according to inflation measured by the Consumer Price Index, rounded to the nearest $500.
Retirees, mid-career investors, and younger savers can all benefit from using the TFSA to meet financial goals.
Retirees can take advantage of the tax-free properties of the TFSA to earn additional income that won’t put their Old Age Security (OAS) pensions at risk of a clawback. The CRA implements the OAS pension recovery tax when net world income tops a minimum threshold. Money received from TFSA investments are not used in the net world income calculation.
Investors in the middle years of their work life can use the TFSA as a retirement savings tool to complement their RRSP investments and company pensions. The 2020 pandemic has also prompted people to use the TFSA to create an emergency fund.
Younger investors can take advantage of the TFSA to start building their retirement portfolios. The TFSA is more flexible than an RRSP when it comes to getting full access to funds. In addition, advisors often suggest saving RRSP room for later years when a person would normally be in a higher tax bracket. The RRSP contributions are used to reduce taxable income for the relevant contribution year.
Best stocks for TFSA investments
Inside a TFSA the full value of dividends and capital gains remain beyond the reach of the CRA. Income investors, such as retirees, can put the money right into their pockets.
Investors who use the TFSA to build a fund for retirement or another savings goal can use dividends to buy new shares. This strategy harnesses the power of compounding. The impact on the portfolio can be substantial over the course of two or three decades.
The top stocks to own tend to be those that pay reliable and growing dividends supported by higher revenue and increased profits.
Let’s take a look at one top stock that has rewarded long-term investors with fantastic returns and should continue to be an attractive pick for a self-directed TFSA portfolio.
Royal Bank
Royal Bank (TSX:RY)(NYSE:RY) is Canada’s largest financial institution and one of the top 15 globally by market capitalization. The bank faces challenges in the current environment with pandemic lockdowns driving up unemployment. So far, government aid and deferrals on loans have helped households and businesses navigate the storm. The economy is recovering, but ongoing pain is expected through the first half of next year.
That said, Royal Bank remains a very profitable business and has the capital to ride out the downturn. The dividend should be very safe. Investors who buy the stock today can get a 4.5% dividend yield.
A $20,000 investment in Royal Bank just 25 years ago would be worth $600,000 today with the dividends reinvested. This would now generate $27,000 per year in dividend income.
The bottom line
The TFSA is a useful savings tool for Canadians at all points of their careers. Those that have a number of years before retirement can take advantage of the power of compounding to build a significant personal pension fund.
While Royal Bank remains attractive as part of a diversified TFSA portfolio, other top stocks in the TSX Index should also be on your radar.
If you run up a multi-million-dollar TFSA balance by trading options frequently, the CRA may deem your trading activities to be a business and tax you accordingly. In this scenario, you'll pay even more taxes than you would in a normal account, because income taxes are higher than capital gains and dividend taxes.
While a TFSA is not specifically designed as a retirement savings account, its flexibility potentially can make it an excellent complement to an RRSP. If you have already maximized your RRSP contributions, then a TFSA may be an option for you to save more money and get the benefits of tax-free growth and withdrawals.
Fairly basic, it works just like a regular savings account. You put cash in, and, over time, it earns interest with a guaranteed rate of return. The big difference is that the interest you earn with your TFSA is tax-free.
At any time in the year, if you contribute more than your available TFSA contribution room you will have to pay a tax equal to 1% of the highest excess TFSA amount in the month, for each month that the excess amount stays in your account. For more information, see Tax payable on excess TFSA amount.
No tax deductions: The biggest drawback of a TFSA, is that your contributions are made with after-tax dollars and are not tax deductible, unlike the FHSA and RRSP. Contribution limits: Though there is no lifetime maximum contribution limit, there is an annual contribution limit, stipulated by the Government of Canada.
You can keep contributing to a TFSA for as long as you live, unlike an RRSP which you must convert to a RRIF at age 71. If you have more retirement income than you need, you can place it in your TFSA, providing you have contribution room. Your TFSA contribution room will continue to grow annually as long as you live.
The TFSA allows flexibility in contributions and withdrawals, but misunderstanding these rules can lead to over-contribution and penalties. For instance, if you contribute the maximum amount early in the year and then withdraw a significant sum mid-year, you can't re-contribute that amount until the following year.
Yes, you can lose money on a TFSA, but it is easy to avoid losing your money. Typically, people who lose their money on a Tax-Free Savings Account are people who are using it for more volatile investments or people who are over-contributing.
You can – and probably should – have both. Both a TFSA and a savings account have their purposes. Having both in your financial portfolio is a pretty good idea. One gives you savings freedom in the short term, the other gives you more potential for savings growth in the long term.
For the lowest income group—people earning less than CAD 5,000—the average TFSA balance is about CAD 17,000. For people earning between CAD 15,000 and CAD 20,000, the average TFSA balance is about CAD 21,000. TFSA balances rise to about CAD 60,000 on average for people earning more than CAD 250,000.
Contribute often to see your money grow, tax-free. Since the money you earn from investments you hold in a TFSA (interest, dividends tooltip or capital gains tooltip ) is not taxed, it has the opportunity to grow faster than it would in a non-registered account.
Since the money you earn from investments you hold in a TFSA (interest, dividends tooltip or capital gains tooltip ) is not taxed, it has the opportunity to grow faster than it would in a non-registered account.
Introduction: My name is Twana Towne Ret, I am a famous, talented, joyous, perfect, powerful, inquisitive, lovely person who loves writing and wants to share my knowledge and understanding with you.
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