It’s a pretty safe bet that most of us know the benefits of having a TFSA, but how to get the most out of one tends to be less clear.
While you can always use a TFSA to park your cash and earn interest tax free, you can also use this account to invest in a variety of assets, where capital gains, dividend payments and interest income are sheltered from taxes.
There are different kinds of TFSAs, which usually refer to the different investments that can be held within these vehicles: deposit, annuity or trust arrangement.
What Can You Hold in Your TFSA?
Cash, Savings Products & GICs
Mutual Funds & ETFs
Stocks (Canada & U.S. listed)
Bonds (Canada & U.S. issues)
Gold & Silver
Mortgages & MICs
Options (long only & covered calls)
Non-USD denominated foreign assets
Foreign currencies other than USD
Digital or crypto currencies
Direct real estate
*Note that this list refers to what the Canada Revenue Agency (CRA) allows in a TFSA. Not all of these investments will be allowed depending on the institution and their custodial relationships.
What Should You Hold in Your TFSA?
The answer to this question depends on a few things, including your tax situation, overall portfolio asset mix, investment time horizon for these funds, as well as what other account types you have (both tax-sheltered and open or non-registered).
The prevailing wisdom is that you want to maximize the growth that benefits from the tax shelter so many will opt to put equities and/or equity mutual funds in their TFSA. But, only 50% of capital gains are subject to tax in Canada. Meanwhile, interest income is 100% taxable so there are some who think it makes more sense to put fixed income or bonds in a TFSA.
However, when bond yields are low, you may want to shelter a greater amount by investing in equities or equity-linked vehicles in your TFSA. And, if you think the price of gold or mortgage interest income will appreciate, you could also make an argument for holding precious metals or mortgages in a TFSA.
Meanwhile, seriously risk-averse investors might choose to invest in a savings product or GICs in their TFSA. Note that many of the advertised rates for savings products are introductory offers and fall precipitously thereafter.
Your overall asset mix and suite of accounts are important because you want to stick to your target mix and figure out which asset classes belong in which account type within your overall portfolio. You can deposit up to the lifetime contribution amount in any of the permitted investments, but how you allocate investments within those limits is your decision to make.
You should also consider any income and capital requirements as well as a timeline for those anticipated needs. It’s quite common for time horizons and risk tolerance to vary across accounts and from your overall risk tolerance. You can always access the money in a TFSA, but withdrawn amounts are added back to your contribution room at the beginning of the next year.
Foreign Assets in TFSAs
All of your investments grow tax free in a TFSA, but there are some instances where you will be subject to taxation — just not on the growth. The most common scenario that triggers tax in a TFSA is where a U.S. investment pays dividends, which are subject to a 15% withholding tax. For this reason, it may make sense to hold U.S. investments that pay dividends in an RRSP rather than a TFSA.
Investments subject to foreign income taxes are less suited to being held in a TFSA and this situation can get pretty complicated. Also, the investor will have no ability to recoup this tax through a foreign tax credit or deduction. The specific treatment will hinge on the details of any existing tax treaties with Canada or the lack thereof.
At the end of the day, the best TFSA investment option for you is the one best suited to your financial goals and needs. You should carefully take stock of your situation and do some number crunching before you make any decisions.