Experts have long recommended that investors set up their portfolios to be as tax efficient as possible by utilizing both registered and non-registered accounts. This is referred to as portfolio allocation, and is meant to view all of your investment options, types of accounts, and the tax consequences for your returns.
Investors were ideally supposed to place interest paying investments inside their RRSP, since they are fully taxable outside of a registered account. And because of the dividend tax credit, investors should hold Canadian dividend stocks in a non-registered account.
But then along came the Tax Free Savings Account and everything changed. Canadians 18 years or older can save up to $5,000 a year tax-free, and unused contribution room can be carried forward indefinitely. Cash, stocks, bonds, GICs, and mutual funds are all eligible contributions. You can withdraw money at any time in any amount without being taxed, and re-contribute the full amount on a yearly basis.
Benefits of TFSA vs Non-Registered Account
Investors are not taking full advantage of the TFSA at this time, with most individuals just parking their money in a high interest savings account. They also continue to believe that their Canadian dividend growth stocks are better off in a non-registered account. But with the potential for tax-free growth inside the TFSA, investors may be wise to re-think their strategy.
Not only will their Canadian equities grow tax-free, foreign dividend paying stocks are also free of Canadian taxation (with the exception of the U.S. 15% withholding tax). And for seniors, any TFSA withdrawals in retirement is not considered income, therefore not affecting eligibility for government benefits such as Old Age Security.
The only drawbacks I see in the TFSA vs. non-registered account debate is that you cannot claim a capital loss for any investments held within your TFSA, and the annual contribution room is quite small ($5,000) for those investors who want to convert their non-registered portfolio into a TFSA right away.
A high interest savings account shouldn’t be held in your RRSP or TFSA just to be tax efficient. Remember that many years ago you could get double-digit interest rates on GIC’s and savings accounts. Not anymore.
Shouldn’t investing be about maximizing your returns, not your tax efficiency? For individuals who have maxed out their RRSP contributions, or have a defined benefit pension plan with very little RRSP room, the Tax Free Savings Account is a great vehicle to use for investing in stocks and REIT’s.
Conventional rules of portfolio allocation are also being tested as older investors start to recognize the benefits of using the TFSA as part of their overall retirement plan. For younger investors, the small annual contribution room is not as much of a factor since their time horizon is much longer. The tax-free growth compounds over time, and will not be considered income when withdrawn in retirement.
Personally I do not have a non-registered account, instead choosing to maximize my TFSA with Canadian dividend paying stocks and REIT’s. This makes sense for my situation and for my retirement goals.
I hope that individuals do the math for their own situation when choosing investments, rather than relying on old rules of thumb about where their investments should be held.
Who wins the battle between the TFSA vs non-registered accounts?