Canadians still not tuning in to TFSA investment advantages

Canada's tax-free savings account (TFSA) savings option has been around since 2009, but Canadians still largely misunderstand it.

According to the annual BMO TFSA report, 66% of Canadians claim to be knowledgeable about TFSAs, but only 22% correctly identified the contribution limit and 77% don’t know the over-contribution penalties. That would explain why one in 10 has inadvertently over-contributed in the past, paying an average of $412.50 in penalties. 

TFSAs are available to Canadian residents 18 years of age or older who can save up to $5,500 per year in cash and investments. Unused contribution room can be carried forward indefinitely. Withdrawals can be made any time in any amount, without being taxed, and can be fully re-contributed the following calendar year.

An investor who has never contributed to a TFSA and has been eligible to do so since 2009 can invest up to $36,500 in 2015.

TFSAs are useful for all types of investors. They make sense for young people, beginning to save for retirement, who are still in lower income tax brackets and don’t benefit much from the tax deductibility of registered retirement savings plans (RRSPs). It makes more sense to accumulate RRSP headroom until their marginal tax rate is higher.

Older investors also gain specific benefits. Unlike with RRSPs, a withdrawal from a TFSA is not considered income and doesn’t affect eligibility for old age security (OAS).

Seniors can move income-producing investments into TFSAs to prevent or reduce OAS clawbacks.

Families can take advantage of the fact that attribution rules do not generally apply, so individuals can contribute to the TFSAs of other adult family members, effectively splitting income. Such contributions don’t affect individual contribution limits.

Investors in higher income tax brackets, who maximize RRSP contributions, can use the refunds to fund TFSA contributions.

The invested refund can grow without fear of taxation either now or in retirement, essentially multiplying the positive impact of the original RRSP contribution.

The key to maximizing TFSAs is choosing the right investments.

Data shows TFSAs are still primarily made up of cash (60%), followed by mutual funds (25%) and guaranteed investment certificates (GICs) (20%). Using TFSAs for cash and GICs is not making best use of them.  The cash may earn tax-free interest, but that advantage in a low rate environment is minimal. TFSAs should be used for investments offering better growth potential. 

Consider a scenario where one investor buys an equity product while another leaves the TFSA in cash.

An investor who contributed $5,500 to a TFSA last year, fully invested in an exchange-traded fund earning 10% for the year, would have a tax-free profit of $550. However, the investor who left the contribution in cash generating 1.5% received only $82.50. The difference speaks for itself. •

Kim Inglis (www.reynoldsinglis.ca) is an investment adviser and portfolio manager with Canaccord Wealth Management, a division of Canaccord Genuity Corp. The views in this column are solely those of the author.