Tax-Free Savings Account (TFSA) investors are thrilled with the new contribution limit for 2021. I mention “investors” and not “users” because only 62% use the account for its intended purpose. A recent Bank of Montreal survey reveals that 38% of Canadians with TFSAs have cash as the primary investment.
Although the name suggests it’s a savings account, a TFSA is primarily an investment vehicle born in 2009 following the 2008 financial crisis. The federal government’s goal was for Canadians to have a facility where they can save faster to secure their financial futures. If you’re storing cash, it’s a colossal TFSA mistake.
The same BMO survey reveals that just 49% of the 1,500 respondents know their TFSAs can hold both cash, and at least one other type of investment. Cash is a safety net to many, although it’s not advisable to keep them in a TFSA. You’ll miss out on the benefits of this tax-advantaged account.
Any interest, gain or dividends earned in the account are tax-free. Idle cash will not grow or compound, and, therefore, you’re under-using your TFSA. Financial planners advise against stockpiling cash in a TFSA because it’s not the place for dead money.
Please don’t underestimate the power of the TFSA to help you achieve both short-term and long-term financial goals. The optimal use is to invest in income-producing assets like bonds, ETFs, GICs, mutual funds, stocks. As mentioned, you don’t pay taxes on all money you make from your TFSA.
The only time the Canada Revenue Agency (CRA) will intervene is when you over-contribute. You incur a 1% penalty tax per month on the excess amount. Avoid it by keeping track of your available contribution room. Similarly, your unused contribution room in a year carries over to the next.
Holding cash exclusively in a TFSA pays back the least, if not zero. However, if you go for dividend stocks, you must make sound choices. When you invest in high-risk stocks, you could lose your contribution room and never get it back.
If you were to maximize your contribution next year, the hands-down choice of TFSA investors for 2021 is the Royal Bank of Canada (TSX:RY)(NYSE:RY). In case you own shares of the bank already, buy some more. How can you go wrong with Canada’s largest bank and most valuable brand for five consecutive years now?
At the pandemic’s height in March 2020, RBC shares tanked to as low as $75.76. As of December 29, 2020, the price is $105.39 or a year-to-date gain of 7%. This $149.93 billion banking giant pays a respectable 4.12%. Also, the quarterly payouts are safe and sustainable, given the less than 55% payout ratio.
RBC’s dividend track record is 15 decades and counting. Furthermore, it boasts of a nine-year dividend growth streak (7.5% annually). If you’re saving for retirement, buy the stock today and never sell. Your income stream should be for life.
Not the king
Apart from the new TFSA annual contribution limit for 2021, the available contribution room for anyone who has yet to open an account is $75,500. Imagine the tax-free income you can generate from that sizable amount. Cash is king, but not in a TFSA.
Speaking of a huge TFSA mistake most Canadians commit...
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Fool contributor Christopher Liew has no position in any of the stocks mentioned.