The new year brings another additional $7,000 of Tax-Free Savings Account (TFSA) room for tax-free returns. You don’t need to rush into it, though. You should not feel the fear of missing out. Instead, plan carefully how your TFSA should complement your entire investment portfolio, which might include a Registered Retirement Savings Plan (RRSP), a company pension plan, a First Home Savings Account (FHSA), and savings accounts.
Because interest income is taxed at your marginal tax rate, some Canadians choose to earn (at least some of their) interest income in their TFSAs. Others focus on growth, potentially with U.S. stocks that ideally pay no dividends, which should hopefully drive outsized capital gains down the road for sizeable wealth creation. (There is a foreign withholding tax of typically 15% on U.S. dividends, which is why it would be smart to consider solid no- or low-dividend U.S. growth stocks in TFSAs.)
Others prefer to be income focused. Canadian real estate investment trusts (REIT) are good considerations for the TFSA, given the more complex taxation on their cash distributions. Quality Canadian dividend stocks are good, too. However, because eligible Canadian dividends are taxed at lower rates in non-registered accounts, some investors save their TFSA room for other stocks.
There’s really no need to be hasty to make your TFSA contribution right away. Just because someone invests earlier in the year in a stock doesn’t necessarily mean they’ll get the best price for the year. Besides, the Canadian and U.S. stock markets had a nice rally of about 12% and 15%, respectively, since the bottom in October. So, they may be due for a pullback anyway.
In terms of earning interest income, it depends on where interest rates are headed. If you think the Bank of Canada will cut interest rates soon, then you might want to lock some money in Guaranteed Investment Certificates (GICs), for example.
Canadian REIT example
As I said earlier, I believe the TFSA is a good place to hold Canadian REITs. As the Bank of Canada has raised interest rates since 2022, the REIT sector remains depressed because real estate investing generally requires sizeable debt levels. Yet the sector should appeal to income investors for its generation of good monthly income.
For example, investors probably still have a bad impression of RioCan REIT (TSX:REI.UN) because the retail REIT cut its monthly cash distribution by a third in 2021. The stock still trades at a relatively cheap valuation today. So, it offers a nice cash distribution yield of approximately 5.8%. This cash distribution appears to be sustainable, with a payout ratio of roughly 61% of funds from operations. And its overall portfolio has a high committed occupancy rate of 97.5%.
At $18.60 per unit at writing, RioCan REIT trades at about 10.5 times its funds from operations. Over the next few years, it has upside potential of about 28% to 56%. Its development projects, of which some are located on existing income-producing properties, could help drive that valuation gap and growth. Additionally, the REIT has a relatively low long-term debt-to-capital ratio.
Investing takeaway
Again, there’s no need to rush into maximizing your TFSA immediately. Instead, investors should plan carefully how their TFSAs should complement their entire investment portfolio and identify investments that are suitable for their unique situations.
