Using your $6,000 of Tax-Free Savings Account (TFSA) contribution room effectively is the key to maximizing your returns. There are a number of factors in each of these accounts that can help you on your way to realizing your financial dreams.
In this article, I will describe some of the benefits of each account, which stocks you should put into these accounts, and how you can maximize returns in a tax-efficient manner.
TFSA planning and income stocks
So what should you keep in your TFSA? The first type of stock should be ones with payouts that are fully taxable. Any company that pays distributions, such as REITs and Limited Partnerships (LP), should be in your TFSA.
These companies have complicated payout structures that are fully taxable, so you would be wise to avoid the headache and keep them in your TFSA. Some examples of these companies are Riocan REIT (TSX:REI.UN) and Brookfield Renewable Energy Partners LP (TSX:BEP.UN)(NYSE:BEP).
The yield from these stocks is huge, so you might as well keep it all. At the moment, Riocan has a yield of over 9% and BEP pays about 4.46%. Given that Riocan’s CEO has publicly stated that it will keep paying the distribution and that BEP just increased its payout by 5%, you might want to hold these in a tax-free account.
Stocks from countries with tax treaties
There are a number of stocks from other countries that are worth buying in a TFSA. Britain, for example, does not require foreign holders of its ADRs to pay withholding taxes.
A withholding tax is a tax on the dividend that many countries charge foreign investors. Income from U.S. dividend stocks, for example, is subject to a 15% withholding tax on each dividend received.
British stocks like Unilever PLC are not subject to a withholding tax. The dividends are fully taxable in a taxable account, however. If you put these stocks into your TFSA, you will be able to receive dividends from these British companies tax-free in U.S. dollars.
Stocks without dividends
Another sort of stock that might be worth keeping in your TFSA is a stock that does not have a dividend. Tech stocks are frequent examples of companies that might be suitable to put into your TFSA.
Let’s say you bought a growth stock like Shopify Inc. at the IPO price. Now let’s assume that you held it to its current price of about $1.400 at writing. You would have a massive capital gain that is tax-free in the TFSA. Apart from your TFSA, you would have to pay capital gains tax on the earnings, a huge difference in earnings.
Of course, there is a downside to holding dividend-less growth stocks in your TFSA. Let’s say you bought BlackBerry Inc. at $140 and rode it up to its high of around $220. Then let’s say that you rode it all the way back down to its current price of $6. If it were in a taxable account, you could use it as a tax loss. In a TFSA, you would have to absorb the loss.
If you are confident in the stock as a long-term hold, buy it in a TFSA. If it seems like a high-risk bet, it might be better to keep off buying it in a taxable account.
The bottom line
Maximizing your accounts is one of the best ways to increase your earnings over time. Think of the tax savings as an extra dividend since that would be lost money outside your TFSA.
Be prudent about what you keep in that account. British dividend stocks, REITs, and stocks without dividends are your best bet for TFSA allocation.
Don’t forget the first rule, though. If you only have enough money to put into a TFSA and RRSP, fill up those accounts first! Maximize your tax-free investments at all costs. It will be your biggest compounding tool. Hold, collect, and grow your earnings.
Renowned Canadian investor Iain Butler just named 10 stocks for Canadians to buy TODAY. So if you’re tired of reading about other people getting rich in the stock market, this might be a good day for you.
Because Motley Fool Canada is offering a full 65% off the list price of their top stock-picking service, plus a complete membership fee back guarantee on what you pay for the service. Simply click here to discover how you can take advantage of this.
Fool contributor Kris Knutson owns shares of Brookfield Renewable Partners, Unilever PLC and RIOCAN REAL EST UN. Tom Gardner owns shares of Shopify. The Motley Fool owns shares of and recommends Shopify and Shopify. The Motley Fool recommends BlackBerry and BlackBerry.