Canadians using TFSAs, just not wisely

We’re using TFSAs, just not wisely

Nearly half of Canadians have a TFSA, but few are housing top earning investments inside the tax-sheltered account.


Close-up of piggy bank in shopping trolleyNearly half of Canadians (48%) have a Tax Free Savings Account (TFSA), up 23% from this time last year, according to a BMO report published Thursday. The adoption rate is certainly encouraging. Unfortunately, the study also found the majority of TSFA holders don’t understand the specifics of how the TFSA works; as a result most aren’t harnessing its true power.

Just 11% of Canadians who responded to the poll (conducted by Pollara for BMO) correctly identified all six eligible TFSA investments. And only 19% know the annual contribution limit is now $5,500, up from $5,000 in 2012. Less than half (47%) know how much you are allowed to re-contribute after making a withdrawal.

Saving is good, but saving efficiently is better

Do any of these nitty-gritty details matter? Isn’t the important thing that Canadians are saving? Well, yes and yes. You see, understanding the rules can make a huge difference in how fast your annual contribution grows. It can mean the difference between a $30,000 TFSA account and a $50,000, $60,000 or even a $300,000 TFSA account. Don’t believe me? Just read The Great TFSA Race from the December/January issue of MoneySense. Julie Cazzin profiled seven investors who are putting their TFSA to work using a number of different investment strategies: some risky, others pretty vanilla. What they all have in common is an in-depth understanding of the TFSA rules, specifically as they relate to investment options. To be clear, you can hold mutual funds, stocks and ETFs inside your TFSA, as well as fixed income. The former have higher yield potential than cash or GICs,  yet so few Canadians are holding them in their TFSAs where they can grow tax-free. I repeat, tax-free. The BMO study found cash is the most common component  held in TFSAs (57%), followed by mutual funds (25%) and GICs (23%), stocks (14%) and ETFs (5%).

Contribution confusion

Confusion surrounds annual TFSA contribution limits as well. The federal government raised the annual contribution limit to $5,500 as of last year. For prior years dating back to 2009, when the first TFSA contributions were possible, contributions were capped at $5,000 per year. Over-contributions result in 1% tax on the amount in excess of the limit. But it’s not over-contributions that’s plaguing most Canadians, I would wager. The BMO report found only one in 10 TFSA holders have over-contributed since opening an account over the past five years. My guess is that under-contribution is a bigger problem among Canadians with means. That’s because the TFSA allows you to withdraw funds at any time and—here’s the kicker—you gain back contribution room equal to your withdrawal the next calendar year in addition to the new annual allowance. Let me explain. All eligible Canadians have accumulated a total contribution room of $25,500 by now, including $5,500 for this 2013 calendar year. Let’s say you are one of the lucky few who have managed to max out your contributions every year and you withdrew all that money today, all $25,500 of it. You could in theory put it all back in January, plus the $5,500 of free space that opens up in 2014 for a total of $31,000. Most of us don’t have that kind of money just lying around to invest using a TFSA but the concept is no less important with a smaller amount, especially if some of your money is sitting in non-sheltered accounts where you’re paying tax on the gains.

So this December, do a quick survey of your portfolio to see whether you have any money in non-registered accounts. Calculate how much unused contribution room you have and will have as of January. Then, shortly after New Year’s move as much money as you can from non-registered accounts into the TFSA and invest it in your choice of mutual funds, GICs, stocks and/or ETFs. Then watch your money grow faster, tax-free. Remember, you can take it out anytime without penalty and put it back in 2015.

Need help calculating your total contribution room? You can determine your TFSA contribution room by going through one the following government services My AccountQuick AccessTax Information Phone Service (TIPS) or by using this spreadsheet. The process isn’t easy but it’s worthwhile, especially if you have TFSA assets with more than one financial institution.

The Great TFSA Race gave me the nudge I needed to move my dividend-paying stocks inside the TFSA. Now it’s your turn. TFSA holders plan to contribute an average of $3,625 this year, according to BMO. You work hard for your money. Might as well make it work hard for you.