The government created the TFSA in 2009 to give Canadians a new vehicle for saving money for the future.
TFSA 101
Since its inception, the TFSA contribution limit has increased each year and is now as high as $69,500. The TFSA limit increased by $6,000 in 2020.
The TFSA limit hike for 2021 will be at least $6,000. The CRA raises the size of the annual increase according to inflation measured by the Consumer Price Index, rounded to the nearest $500.
Retirees, mid-career investors, and younger savers can all benefit from using the TFSA to meet financial goals.
Retirees can take advantage of the tax-free properties of the TFSA to earn additional income that won’t put their Old Age Security (OAS) pensions at risk of a clawback. The CRA implements the OAS pension recovery tax when net world income tops a minimum threshold. Money received from TFSA investments are not used in the net world income calculation.
Investors in the middle years of their work life can use the TFSA as a retirement savings tool to complement their RRSP investments and company pensions. The 2020 pandemic has also prompted people to use the TFSA to create an emergency fund.
Younger investors can take advantage of the TFSA to start building their retirement portfolios. The TFSA is more flexible than an RRSP when it comes to getting full access to funds. In addition, advisors often suggest saving RRSP room for later years when a person would normally be in a higher tax bracket. The RRSP contributions are used to reduce taxable income for the relevant contribution year.
Best stocks for TFSA investments
Inside a TFSA the full value of dividends and capital gains remain beyond the reach of the CRA. Income investors, such as retirees, can put the money right into their pockets.
Investors who use the TFSA to build a fund for retirement or another savings goal can use dividends to buy new shares. This strategy harnesses the power of compounding. The impact on the portfolio can be substantial over the course of two or three decades.
The top stocks to own tend to be those that pay reliable and growing dividends supported by higher revenue and increased profits.
Let’s take a look at one top stock that has rewarded long-term investors with fantastic returns and should continue to be an attractive pick for a self-directed TFSA portfolio.
Royal Bank
Royal Bank (TSX:RY)(NYSE:RY) is Canada’s largest financial institution and one of the top 15 globally by market capitalization. The bank faces challenges in the current environment with pandemic lockdowns driving up unemployment. So far, government aid and deferrals on loans have helped households and businesses navigate the storm. The economy is recovering, but ongoing pain is expected through the first half of next year.
That said, Royal Bank remains a very profitable business and has the capital to ride out the downturn. The dividend should be very safe. Investors who buy the stock today can get a 4.5% dividend yield.
A $20,000 investment in Royal Bank just 25 years ago would be worth $600,000 today with the dividends reinvested. This would now generate $27,000 per year in dividend income.
The bottom line
The TFSA is a useful savings tool for Canadians at all points of their careers. Those that have a number of years before retirement can take advantage of the power of compounding to build a significant personal pension fund.
While Royal Bank remains attractive as part of a diversified TFSA portfolio, other top stocks in the TSX Index should also be on your radar.
