The tax-free savings account (TFSA) is one of the best options investors have for building a significant nest egg for retirement.
Anyone who turns 24 or older in 2015 has eligible TFSA contribution room of $41,000. The program began back in 2009 with a limit of $5,000, which continued through 2012. In 2013 and 2014 the limit increased to $5,500 and then jumped to $10,000 this year.
The Liberal government is expected to roll the annual contribution back to $5,500 for 2016, but that’s still enough for young middle-class savers to build a mountain of money.
How to invest in the TFSA?
Many people stuff their TFSAs with GICs and Canada Savings Bonds. That makes sense if you have zero risk tolerance and want to avoid tax on the interest you earn, but the big power of the TFSA lies in the tax-free capabilities of reinvesting dividends and protecting capital gains.
By purchasing solid dividend-growth stocks and using the distributions to buy more shares, investors can harness the power of compounding to build a healthy portfolio with relatively small amounts of initial savings.
Which stocks are best?
Ideally, savers want to own companies that hold dominant positions in an industry with high barriers to entry. The stocks should also have long histories of reliable dividend growth supported by increasing earnings.
The Canadian market has a large number to choose from, but BCE Inc. (TSX:BCE)(NYSE:BCE) and Royal Bank of Canada (TSX:RY)(NYSE:RY) are two that stand out.
BCE
BCE is a media and communications juggernaut. The company has amassed a portfolio of assets all along the value chain that enable it to pick off a bit of revenue from most Canadians every day.
How?
Any time someone in Canada buys a new communications device, watches a sports game, sends a text, downloads a movie, checks e-mail, listens to the weather report, or watches the news, there is a good chance the interaction involves at least one of BCE’s assets. That’s a great business.
BCE is a veritable cash machine, and management is quite generous when handing out the profits to investors. The stock pays a quarterly dividend of $0.65 per share that yields about 4.5%.
A $10,000 investment in BCE 10 years ago would be worth about $32,000 today with the dividends reinvested.
Royal Bank
The Canadian economy is working through a rough patch, but Royal Bank is more than capable of riding it out, just as it has survived every other difficult market for the past 150 years.
The bank earns billions of dollars in profits every quarter and is investing heavily in growth areas like wealth management. Royal Bank is also partnering with FinTech companies to make sure it can hold its own against the onslaught of non-bank mobile payment competitors.
The stock comes with a quarterly dividend of $0.79 per share that yields 4.2%. Management just hiked the payout, so Royal Bank can’t be overly concerned about the economy or the housing bubble.
A $10,000 investment in Royal Bank 10 years ago would be worth about $27,000 today with the dividends reinvested.
