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Getting maximum benefit from your TFSAs

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A poll conducted this summer showed just less than half of Canadians have a tax-free savings account. That's actually a pretty good start, after just four years. But a concern is that 41 per cent of those polled said they had "no plans" for the money.

The same poll -- arranged by CIBC -- also found most TFSA-holders just invest in savings-account-style investments, earning almost nothing, as opposed to investing to actually make their principal amount grow.

These guaranteed savings vehicles are great for short-term goals, such as vacations, renovations, major purchases, or emergencies. The funds in the TFSA can be withdrawn at any time without any taxes payable, so this is a reasonable use of the account.

However, it's hardly worth it, if you are earning only, say, 1.5 per cent interest for a year or two. Let's say you have contributed the maximum for the four years allowed. That's a total of $20,000 of principal.

An assumed 1.5 per cent interest rate would earn you $300 for a full year, which would be tax-free. If earned in a regular account, the tax would be between zero and $138, depending on your tax bracket and rate. The average Canadian would pay about $90 a year in tax on that amount of interest.

If an amount is withdrawn from the TFSA, it cannot be redeposited until the following year. Of course, the tax saving is also reduced for that part-year.

What am I suggesting instead?

That the TFSA can be invested in equity investments, such as company shares, real estate investment trusts or equity mutual funds, and earn more, and then stay invested for long-term goals such as retirement funding.

Using the TFSA to complement your other retirement vehicles such as RRSPs and pensions has many advantages. Those other sources are fully taxable when you draw on them. That makes them inefficient for lump-sum needs, such as car purchases, major trips, renovations or emergencies, in retirement.

As well, RRSP withdrawals, pensions and investment income on non-registered accounts are part of the calculation of "net income" on your tax return. This is used to determine your eligibility for a number of tax credits, and possibly even the amount you get from old age security after 65.

So let's look at an example of how this strategy could work. If someone had contributed $5,000 a year to a TFSA since 2009, the year they started, that person would now have $20,000 of principal, plus growth. Let's say growth averaged six per cent a year, making the current balance about $21,875. (We have clients with a great deal more than that in their TFSAs that were started in 2009, so it's quite a reasonable assumption.)

If that person is 20 years away from retirement, contributes $5,000 a year and earns six per cent on average, then the account will be worth over $250,000. It could then be earning $10,000 a year or more in dividends, with likely capital growth on top of that, all tax- and clawback-free.

Alternatively, it could then be invested in guaranteed investments, earning a smaller amount of tax-free interest, but guaranteeing the value. Principal amounts can be withdrawn at any time without tax.

Remember, equity investing has risks, and the prices and values of equities go down as well as up.

You need to invest appropriately for your own overall situation, your time horizon and your risk tolerance. That's a discussion that needs to take place between you and your investment adviser (even if you are a do-it-yourself investor), which will hopefully result in a written investment policy statement.

Sticking with that policy -- even when the markets are bad for an extended period -- is likely to be your best route to long-term success.


David Christianson is a fee-for-service financial planner with Wellington West Total Wealth Management Inc., a portfolio manager (restricted).

Republished from the Winnipeg Free Press print edition September 7, 2012 B5

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