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TFSAs – Beyond the Basics

16 February 2023

Whether you’re investing for the long term or saving for a big-ticket item, the Tax-Free Savings Account (TFSA) offers a unique advantage not available anywhere else in Canada’s investment landscape. If your goal is to maximize your investment dollars and avoid interest, dividends and capital gains taxes on a portion of your assets, a TFSA is the way to go. Of course, a TFSA should be viewed as part of a holistic investment strategy – when utilized correctly, it can help you reach your investment goals faster. 

TFSA Basics

Established by the Canadian government in 2009, a TFSA is a registered investment account that gives Canadian residents the ability to invest in financial assets without having to pay taxes on capital gains and investment income. The TFSA enables tax-free growth of all assets held in the account – so long as you don’t exceed your contribution limit and invest in qualified investments. 

Each year, the Canadian government sets contribution limits for TFSAs; this contribution limit applies to all TFSA account holders regardless of their income. In 2022, Canadian residents could contribute up to $6,000 to their TFSA – this figure increases to $6,500 in 2023. Canadian residents begin accumulating TFSA contribution room at age 18, and any unused portion is carried forward indefinitely. In other words, even if you don’t invest up to the contribution limit each year, any unused amount will be carried forward to future years. By 2023, the total contribution amount for Canadian residents who were at least 18 years old in 2009 was $88,000. 

Capital gains and dividend income earned in your TFSA can be withdrawn tax-free and do not result in lost contribution room. For example, if you realized $10,000 in capital gains for the year, you can choose to reinvest that amount in your TFSA or withdraw it without paying tax. If that $10,000 was earned in a non-TFSA account, half of it ($5,000) would be taxed as income at your marginal tax rate. Given the generous tax benefits, a TFSA allows you to keep more of your gains. You can withdraw the money earned in your TFSA to pay for big-ticket items, make a down payment on a new home, pay for education, or use it for any other purpose. 

One of the biggest advantages of a TFSA is the wide selection of qualified investments to choose from. A TFSA allows you to hold stocks, options, mutual funds, exchange-traded funds (ETFs), mortgage investment corporations (MICs), government bonds, certain corporate bonds, guaranteed investment certificates (GICs) and cash. The range of financial assets in your TFSA will largely depend on whether you open a registered TFSA account with your financial institution or opt for a self-directed TFSA. With a self-directed TFSA, your investment choices are not restricted to the funds offered by your bank. Of course, the assets you select must still be qualified investments, as defined by the Canadian government. 

It’s strongly recommended that you track your TFSA contributions since there are penalties for contributing above the government-set limit. Over-contributions are taxed at a monthly rate of 1% for each month the excess amount remains in your TFSA. The best way to track your contribution room is by logging on to Canada Revenue Agency (CRA) My Account. Each February, the CRA updates your current contribution limit to reflect contributionss from the previous year. 

TFSA: Going Beyond the Basics

TFSAs offer the flexibility to invest for whatever purpose you see fit. Whether you’re looking to save for a vacation or top up your retirement savings, a TFSA could be an effective complement to your investment portfolio. Most Canadians associate retirement planning with a Registered Retirement Savings Plan (RRSP). While RRSPs are often the most effective way to invest for retirement, TFSA contributions can help accelerate your retirement savings under the right circumstances. 

RRSPs and TFSAs share a few important similarities: Both are government-directed accounts designed to help Canadian residents invest in financial assets. They each have an annual contribution limit, allow account holders to carry unused contribution room forward indefinitely and share a similar list of qualified assets such as stocks, bonds, GICs and MICs. In the case of qualified assets, both RRSPs and TFSAs are ideal for portfolio diversification. Generally, that’s where the similarities end. 

Most people set up their RRSP and TFSA with different goals in mind. The primary purpose of an RRSP is retirement savings, whereas a TFSA is a general savings account that can be used for any purpose. The major difference between the two accounts centres around taxes. The government encourages you to invest in your RRSP by offering a tax deduction on your contributions. However, you have to pay tax when you withdraw the money. You are also subject to early withdrawal penalties if you take the money out before age 71. TFSAs, on the other hand, offer no up-front tax breaks but allow you to withdraw money, including capital gains, dividends and interest income, without having to pay any tax. 

RRSPs have significantly more contribution room, allowing savers to invest up to 18% of their earned income up to a maximum of $30,780 per year as of 2023. TFSAs, on the other hand, have a maximum annual contribution limit of $6,500, but you don’t need earned income to accumulate contribution room. For RRSPs, contributions must stop the year after the account holder turns 71. There are no such restrictions on TFSA accounts. 

How and when you contribute to your RRSP and TFSA accounts will depend on many factors. While TFSAs aren’t as effective for retirement savings, they may be an effective buffer for individuals who want to retire early. If you retire early and are not yet eligible for government or workplace pensions, withdrawing money from your TFSA could be an effective stop-gap. This also ensures you don’t pay hefty early withdrawal penalties (withholding taxes) on your RRSP before age 71. 

A TFSA can also help you keep your retirement savings on track by allowing you to continue saving when you are unemployed (and hence not contributing to an RRSP or earning contribution room). Finally, a TFSA allows you to continue saving after age 71 – the age you are legally required to convert your RRSP into a Registered Retirement Income Fund (RRIF) or annuity. In any of these cases, a TFSA can be an effective source of tax-free savings – and tax-free income. 

TFSAs also allow you to designate a beneficiary or “successor holder” for estate planning. Like a beneficiary, a successor holder can ensure a smoother transfer of TFSA assets when you pass away. However, unlike a beneficiary, only a spouse or common-law partner can be named your successor holder. A successor holder automatically becomes the holder of your TFSA upon your death and can consolidate it with their own TFSA without affecting their contribution room. 

Mortgage Investments Within a TFSA

Mortgage investment corporations, or MICs, have a place in every investment portfolio – and they are especially well suited for TFSAs. MICs offer access to a portfolio of real-estate backed private mortgage investment opportunities. All that is required is a minimum investment of $5,000. If you have unused contribution room in your TFSA, consider allocating a percentage to a high-quality MIC fund. 

MICs are one of the few classes of alternative assets that are TFSA-eligible, meaning distributions grow inside the account without tax consequences. A MIC works by pooling capital from a group of investors for the purpose of investing in the Canadian mortgage market. Funds deposited into a MIC are pooled and lent out to qualified borrowers, usually in the form of first and second mortgages. Investors who contribute to a MIC receive shares in the underlying fund, which entitles them to regular dividend payments. If you invest in a MIC as part of your TFSA, you can withdraw your dividend payments tax free at any time, or you can re-invest them in additional MIC shares for compound growth. 

Canada’s non-bank mortgage market reached $380 billion in 2022, according to Statistics Canada. This figure is likely to grow as more Canadians seek alternative lending options.. Amid rising interest rates and stricter lending requirements, MICs will continue to play a critical role in meeting Canadians’ residential mortgage needs. It’s estimated that MICs already represent roughly 2% of total mortgage debt in Canada. 

To learn more about how MICs can help you diversify away from volatile public markets, consider working with an experienced private lender. CMI Mortgage Investments is one of Canada’s fastest-growing non-bank financial institutions, having originated more than $1.6 billion in mortgages since inception. Learn more about how CMI MIC Funds can help you super-charge your TFSA. Speak with one of our Investment Professionals today for a free  consultation.

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