Many people are still keeping their Tax Free Saving Account in cash or in a low-interest-bearing vehicle, not realizing there are other options available.
There are plenty of advertisements this time of year encouraging people to open new accounts with the promise of teaser high interest rates for six months or a year, or a $50 bonus. Seems like a no brainer to sign up for the new account, right?
Regrettably, many are missing the fine print where it is disclosed there is a $125 fee should you decide later to transfer. Those teaser rates don’t last forever, and the firms offering rates may have limited investment options.
Your TFSA is not limited to just cash. There are other investments available. Managing equities in your TFSA is a little riskier, but the potential for bigger dividends can offset this risk.
You can have as many TFSA accounts as you wish provided they do not go over the annual limits. The Canada Revenue Agency is on top of people who over-contribute. When the TFSA was first launched, the CRA was more lenient on waiving interest and penalties for those who inadvertently over-contributed. The penalties and tax are severe and could quickly wipe away any benefit of the TFSA if you make an over-contribution.
My advice for anyone with a TFSA is to have only one and to have a strategy for the account.
By maintaining one TFSA, you can easily manage the amount you contributed and don’t have to remember all the details of each of your other TFSA accounts. I also recommend the TFSA account is with the same adviser and financial firm as your other investment accounts. The investments within the TFSA should have a strategy and should complement your other investment holdings. Your adviser will also have the planning software that has been updated in recent years to include the impact of contributing to a TFSA over time.
On March 23, 2011, I wrote an article about having a conservative blue chip stock in the TFSA. I showed this using Clare, who purchased TransCanada Corp. (TRP). Clare bought shares in TRP with her maximum contribution limit at the beginning of each year. The maximum contribution amount for 2013 was raised to $5,500, so as of Feb. 28, 2013, Clare’s TFSA is valued at $34,103.
Back in 2009, Clare’s husband, John, chose to buy Royal Bank of Canada shares instead of TRP. Every year, John has added to his Royal Bank shares in his TFSA by transferring shares he already owns in his non-registered account. He understands with each transfer from his non-registered account he has to pay tax on the realized gain from the shares transferred into the TFSA. Similar to Clare, John has built up a sizable TFSA using one stock. The strategy was suitable for John and Clare as they wished to hold equities within their TFSA, have combined investments of $1 million and wished to assume the concentration risk in one account.
Together, John and Clare have seven accounts — two joint with right of survivorship non-registered (one with John as the primary, and the other as Clare as primary), two TFSA, two RRSP and one locked-in RRSP (resulting in the transfer of a registered pension plan from John's former employer).
John and Clare could see the benefits of having their TFSA accounts at the same institution of their other holdings. We were able to ensure that the investments in the TFSA are complementary to the other holdings they have and to manage overall position size of each investment.
Sixty per cent of John and Clare’s total investments are in equities, or $600,000. For John and Clare’s combined portfolio, I recommended 30 equities with initial positions being approximately $20,000. Their TFSA accounts have investment risk tolerance set at high on both accounts as a result of their concentration in one holding.
If the position exceeds five per cent of the portfolio, I recommend reducing the position, also called rebalancing. If John and Clare wish to continue holding an investment that exceeds five per cent or $50,000, we would have them sign a specific letter stating that they understand the risk associated with more concentration in this investment.
During our March meeting, I suggested John and Clare each consider selling half of their shares and buying a second stock in a different sector that complements the total portfolio. Individuals that wish to have equity exposure within their TFSA accounts should understand the associated risks of concentrating and different options of investing.
Investors with less capital than Clare and John, or who have a lower risk tolerance, should look at a different approach for the TFSA. Once investors obtain a total portfolio of $250,000 or more, I encourage people to look at the benefits of direct equities within a TFSA.
Let’s use a household with total investments of $250,000 with 60 per cent in equities, or $150,000. In this case, I recommend 20 equity holdings at $7,500 each. The TFSA would likely have three to four companies. Capital gains and income are tax-free in a TFSA. Losses within a TFSA cannot be claimed. In other words, if an investment goes down in value more than the income it has generated, it would have been better off to hold it in a non-registered account to be able to have the loss carry forward.
Kevin Greenard CA FMA CFP CIM is an associate portfolio manager with The Greenard Group at ScotiaMcLeod in Victoria. His column appears every second week.
