Spreading your assets across accounts to take advantage of the different tax implications can help investors maximize their returns over time. By minimizing taxes and fully utilizing the various savings instruments, you will keep more money in your pocket. Canada has a number of registered accounts, such as RRSPs, TFSAs, and RESPs, all of which have different uses and tax benefits that investors need to be aware of before placing different investments into one account or another.
While this seems self-evident at first glance, investors need to realize that all the money they have in an asset class, such as securities in the form of stocks and bonds, are one pool of money. Do not spread them evenly across your accounts, because different assets have different tax implications that can have major impacts on returns. The TFSA in particular is a powerful savings device, and all Canadian investors should be making effective use of it.
The TFSA account
The TFSA is best suited for either distribution-paying companies, such as REITS, or interest-bearing investments, such as stocks or bonds, United Kingdom stocks, and solid U.S. growth stocks that do not pay dividends and have a lower risk of capital loss. Prioritize these assets to shelter within the TFSA.
RioCan REIT (TSX: REI.UN) has a large distribution — not a dividend — that would benefit from the tax-sheltered account. The REIT’s distributions are not considered eligible dividends under the tax code and are therefore fully taxable. The payouts are often quite large, so the tax implications can be significant. RioCan, for example, pays a distribution of 5.68% at the current share price. In a TFSA you get to keep the entire payout tax sheltered.
U.K. American Depository Receipts such as Vodafone Group (NASDAQ: VOD) also benefit from the tax-free status. There is no withholding tax on these companies’ dividends, but they are considered to be fully taxable income in a taxable account. The United Kingdom has a tax treaty with Canada, so in a TFSA you get to keep the entire 7% dividend the company pays out.
Companies that do not pay dividends but that trade at more reasonable valuations, such as Alphabet (NASDAQ: GOOG)(NASDAQ: GOOGL), are also well suited for TFSA accounts. Alphabet currently trades at a relatively modest valuation for a stock in the tech sector. Considering it is still growing quite strongly, its valuation may be justified, and you will be able to sell the stock for a profit tax-free in the future. However, if you have any doubt at all as to the valuation of the stock, buy it in a taxable account. If you sell at a loss in the TFSA, you will not get a tax credit.
Bringing it home
This article assumes that investors have enough assets to maximize registered accounts and still have investments in a taxable account. If you can fit all your assets within the TFSA and RRSP, by all means, put everything into them. But once you have outgrown your tax-sheltered accounts, allocate your assets to maximize your tax-free returns. Check with your accountant and financial advisor to make sure that the allocation makes sense for you and your account before you make any changes. Maximize your accounts and supercharge your returns by using your TFSA efficiently.
