Tax Free Savings Account: Three different approaches

The Tax Free Savings Account (TFSA) has been around since January 2009 and many are still confused about what it is and types of investments that can be held within it.

The TFSA is different than a bank savings account that holds cash earning a small amount of interest.  The TFSA has the flexibility of holding cash like a bank savings account, but can also hold a variety of different types of investments, similar to an RRSP with bonds, equities and mutual funds.

When the TFSA was launched, the TSC/S&P Composite Index was at 8,987.70.   Frank, James, and Clare all open a TFSA on the first day, and each had a different view on how to invest within the account.   We have outlined how each of their accounts have performed over the January 1, 2009 to January 2, 2011 period.

■ Frank opens up a TFSA savings account on January 1, 2009 and deposits $5,000.  For purposes of this article, we will assume the savings account earns 1.3 per cent every year.  After the first year, Frank’s TFSA is valued at $5,065.  Frank deposits a further $5,000 into his savings account on January 1, 2010.  On January 1, 2011 Frank deposits another $5,000.  On January 2, 2011 Frank’s TFSA is worth $15,196.

■ James opens up a transactional TFSA account on January 1, 2009 and deposits $5,000 into a three year compound GIC (maturing on January 2, 2012) earning three per cent.  At the end of the first year, James’ TFSA is valued at $5,150.  James deposits a further $5,000 on January 1, 2010 and purchases another three year compound GIC (maturing on January 2, 2013) earning three per cent.  On January 1, 2011 James deposits another $5,000 into his TFSA and buys another three year GIC (maturing on January 2, 2014) earning three per cent.  On January 2, 2011 James’ TFSA is worth approximately $15,454 and he has three GIC’s that are laddered (maturities in early 2012, 2013, and 2014).

■ Clare likes the idea of having a lower risk equity that pays a dividend and also has some growth potential within her TFSA.  On January 1, 2009 Clare deposits $5,000 into her fee-based TFSA and purchases 150 shares of TransCanada Corp (TRP) at a price of $33.17 per share.  We recommend that Clare sets up the Dividend Reinvestment Plan (DRIP) on TRP.  After the first year, Clare’s TFSA has three additional shares from the DRIP program, and a total ending market value of $5,525.  Clare deposits a further $5,000 on January 1, 2010 and purchases another 141 shares of TRP at $36.19 per share.  During 2010, Clare receives a further ten shares of TRP through the DRIP program.  On January 1, 2011 Clare deposits another $5,000 and purchases 133 shares of TransCanada Corp at $37.99 per share.  On January 2, 2011 Clare’s TFSA is worth $16,469 and has 433 shares of TRP.

Each of the above people put in a total of $15,000 of original contributions and took a conservative approach.  The ending market value as of January 2, 2011 for the three investors range between $15,196 and $16,469.  Not illustrated above, are those people who have decided to assume more risk within the TFSA account by holding more aggressive equities.  Given the strength in the markets over the last couple of years, some of these people have already built up a sizable TFSA.  With proper management, early contributions, and time to grow, the TFSA can become a significant account to factor into your financial plan.


Fee-Based TFSA:  If your TFSA is a fee-based account then you should have the fee’s being paid from a non-registered account.  If you have not done this already then you should be able to speak with your advisor on having an amount transferred in to cover fees.  This will enable you to avoid tax on even a greater base amount.

Dividend Reinvestment Plan:  If you choose to invest in a large company paying a dividend then you should discuss setting up the DRIP program.  Many companies also offer a discount for shareholders participating in the DRIP.

Registered Account:  The TFSA is a “registered account”.  If you have a capital loss in a TFSA, you will not be able to claim it like you could in a non-registered account.  You also will not receive new TFSA room for trading losses.  We feel it is important to factor this in when making TFSA investment decisions.

Coupons or Compound GICs:   When you are purchasing direct holdings rather than mutual funds you will have periodic income payments come into the account.  In the TFSA it may be difficult to reinvest a small amount if you purchase direct fixed income (GICs’, bonds, etc.) within your account.   Two good fixed income solutions are coupons (also known as strips or residuals) that are purchased at a discount and mature at a greater value.  Look at compound GICs that are for periods greater than a year.

Property Taxes:  If you are 55 years or older then you are able to defer your property taxes.  Often at times, cash flow is restricted and contributing to a TFSA is not easy.  One strategy that we like is for clients to defer their property taxes and deposit the funds into a TFSA. Even if invested in GICs, similar to James above, you would be further ahead.  The interest rate for the property tax deferment program for the period October 1, 2010 to March 31, 2011, is 0.50 per cent (and 2.5% for certain families with children).

Naming Spouse as Beneficiary and Successor Annuitant:  If you are married then we would recommend that you understand the benefits of naming your spouse as beneficiary and successor annuitant.  Let’s use Frank as an example from up above.  He is married to Louise who has a TFSA valued at $20,000.  Frank has named Louise as both the beneficiary and successor annuitant of his TFSA.  If Frank were to pass away, Louise would be able to roll Frank’s entire TFSA valued at $65,730 into her own TFSA.

Understanding Withdrawals:  If you require cash to live off of then the first place you should look at is your bank accounts and non-registered investment accounts.  The second place you should look is the Tax Free Savings Account (TFSA).  If you do withdraw funds from a TFSA in a given year, you must wait until the next calendar year prior to replenishing the amount withdrawn.