There have been talks that Canadians’ TFSA limit for 2015 has been increased from $5,500 to $10,000. However, the budget bill must be passed before the TFSA increase is approved and becomes law. So, I’d wait for Canada Revenue Agency’s Tax-Free Savings Account page to be updated before contributing that $4,500 amount to avoid the possibility of penalties.
Still, there’s much to like about the current TFSA. If you were at least 18 years old in 2009 and have never contributed to a TFSA, you have a capacity of $36,500. Essentially, you can invest these after-tax dollars tax free forever.
It’s true that interest is fully taxed so Canadians maybe inclined to place their interest-producing vehicles, such as savings account, GICs, and bonds in their TFSAs. However, with interest rates at historical lows, there are better ways to invest in a TFSA. Remember, TFSAs aren’t just a means to save, but a means to invest.
1. Invest in real estate investment trusts
Investments paying an income like real estate investment trusts (REITs) reduce volatility and risk because of the yield they pay out. The yield helps put a floor on price drops. For example, since 2009 Northern Property REIT (TSX:NPR.UN) has only reached over the 6.5% yield three times. So, anytime it goes over that yield, it may be a good entry point to the REIT.
REIT payout distributions and not fully eligible dividends. So, it eliminates any tax hassles when you put them in a TFSA or RRSP. Because REITs generally pay distributions at a monthly interval, TFSAs make the perfect place to put them because you can take out that income for your everyday expenses anytime you need.
2. Invest in high-quality, high-yield dividend stocks
Just like REITs’ distribution yields, dividend yields help put a floor on price drops. Buying high-quality dividend-paying companies in your TFSAs produce tax-free income.
There are many choices if you’re looking for companies that pay out at least 3% per year and typically grow the yield at a 5-7% rate. Most pay out their dividends quarterly.
3. Invest in high-quality companies with high-growth prospects
Some companies grow at a faster rate than the previous category. They are a conservative group that pay a lower yield, but grow the dividend at a double-digit rate. For example, both of these companies generate enough cash flow from their operations to cover their dividends.
Both Canadian National Railway Company (TSX:CNR)(NYSE:CNI) and Enbridge Inc. (TSX:ENB)(NYSE:ENB) have paid growing dividends for 19 consecutive years. The former’s most recent dividend raise was a whopping 25%, while the latter’s was an impressive 33%. Going forward, I expect both to grow their dividends in a double-digit rate, but more likely between 10% and the teens range in alignment with their earnings growth.
High dividend growth supported by high earnings growth leads to higher prices. Buying such high-growth companies in a TFSA allows for tax-free capital gains if you decide to sell some shares, while earning a growing income tax free.
Notes of caution
Most importantly, if you buy the above securities at fair prices or at historically high-yield levels, your diversified, conservative equity portfolio should give you higher returns, complementing interest-producing vehicles you already have.
If you have never invested in the stock market before, I would still suggest investing in a non-registered account first to get a feel of it. Once you feel comfortable, consider investing equities in a TFSA. The reason for this is that income and gains are tax free in a TFSA, just as capital losses can’t be reported to the Canadian Revenue Agency to apply against a corresponding capital gain, while capital losses in a non-registered account can.
Lastly, make sure you don’t make these TFSA mistakes.
