TFSA — The Best Thing to Ever Happen to Canadian Investors

My favourite aspect of being an investor is that it forces a person to look beyond their own front door to assess both macro and micro events across the globe. On the macro level, it becomes necessary to keep an eye on emerging technologies which may reshape the landscape of mature industries. One such change which seems to be picking up steam is the growth of cryptocurrencies and how they might impact the financial industry. On the micro level, it is necessary to research discount brokerages to decide which provide the research capabilities at a reasonable commission and to also understand taxation in order to determine the true risk-to-benefit of a given investment.

Two Key Events

Looking back on my road as an investor, I realize that there were a few serendipitous occurrences which set the stage for me to achieve success right from the outset.

The first major event which accelerated my portfolio’s growth was The Great Recession which really came to a head in 2008 and through which the stock markets hit their bottom in March 2009. Incidentally, I was just finishing university in April of 2009 and would thereafter be in a position where my earned income would be available to invest rather than being socked away to pay for tuition and other school-related expenses.

I ultimately made my first single-stock investment in 2009 with Toronto-Dominion Bank (TD) and haven’t looked back since. Over time, I’ve continued reinvesting dividends and watching my portfolio bloom as post-crisis, the market has been rising steadily as the global economy has seen a remarkable recovery.

The second factor that took place in 2009 with the advent of the Tax Free Savings Account (TFSA). This was the best thing to ever happen to Canadian investors. I will outline its value in this article.

Tax-Free Savings Account (TFSA)

The TFSA program came into effect in 2009 and is designed for Canadians 18 and older. The way this works is that while there is no tax-break on money contributed to a TFSA, investment income and capital gains are generally tax-free, even when withdrawn (there are exceptions such as foreign withholding tax, so be sure to consult a tax specialist).

The contribution limits going back to inception in 2009 are as follows:

Contribution Years	Contribution Limit Per Year ($)
2009-2012	5,000
2013-2014	5,500
2015	10,000
2016-2018	5,500

In other words, assuming you had placed $0 in a TFSA between 2009 and the time of writing in 2018 (and you were eligible in each of the years), you would have $57,500 in available contribution room. In 2015 the contribution limit was bumped to $10,000 as a one-time thing as the Conservative government at the time was campaigning on the promise of increasing this (which many saw simply as an appeal to wealthy voters for whom that would actually matter).

Tax-Free Compounding Matters

To get an idea of the significance of what a TFSA may someday be worth, I plugged the following variables into an online investment calculator from the Ontario Securities Commission –

• Initial Investment: $57,500 (the total maximum available TFSA contribution room)
• Regular Addition: $5,500 yearly (the TFSA contribution limit for TFSA)
• Interest Rate: 6.00% (conservative; below the historical rate of return from stocks)
• Interest Compounded: Yearly
• Years to Grow: 30

The total value of investment clocked in at $765,070.77 with $542,570.77 coming from interest. That’s not chump change. It demonstrates the potential value of investing within a TFSA and sticking with it over time. The number may well be higher based on the “Regular Addition” increasing over time to keep pace with inflation or if the government ever decides to increase the contribution limit.

The beauty of the ~$765k sum is that withdrawing it (or a portion of it) would be tax free!

A Free Lunch

Reaping the full reward of investment activity is a free lunch. This a rare thing. You get an immediate return just by understanding how to structure your investments.

The TFSA program, while it was initially criticized by some as being too small ($5,000 per year to start, though indexed to inflation), has now after a decade shown that it can yield substantial sums for those properly utilizing it.

TFSA Statistics

The TFSA is great, but how well used is it?

I decided to review stats from the Government of Canada’s website. These figures are from 2017 and represent the 2015 contribution year. I rounded as was necessary.

Though these facts are a bit dated, they’re the best I had to work with. That said, it’s fair to assume they remain representative of the situation:

Summary of Statistics	Ages: Below 20 to 29	Ages: 30 to 64	Ages: 65 to +75
Average number of TFSA contributions (per individual)	10.42 to 21.95	8.19 to 21.95	2.99 to 6.13
Average number of TFSA withdrawals (per individual)	6.15 to 7.16	3.21 to 5.09	2.30 to 3.01
Average unused TFSA contribution room	$10,325.29 to $32,088.81	$20,433.58 to $31,190.12	$13,848.67 to $18.532.07
Average Fair Market Value (per individual)	$3,125.99 to $6,562.75	$7,164.83 to $20,800.16	$23,046.66 to $27,828.03

Here are a few interesting observations I’ve made based on the data:

1. The older age groups make far less withdrawals from their TFSAs than the younger cohorts. The most active group for withdrawals (by a long shot) are teenagers to 29 who make two to three times more likely to be withdrawing funds compared to those over 70.
2. Not surprisingly, the average fair market value of TFSAs increase consistently from youngest to oldest. Generally speaking, people are more likely to have accumulated wealth the longer they’ve been around.
3. The younger generation tends to make many contributions to their TFSA, though as noted above. Sadly, this seems to be offset by their withdrawals. The older cohort only contributes a few times per year.

The primary reason those from teenage years to 29 have low sums in their TFSA may well simply be a result of not having enough cash flow to warrant investment at this time. There are many common expenses in this age range including education, beginning a family, and only being at the beginning of their respective careers.

TFSA Confusion

I believe there remains widespread confusion regarding TFSA usage. The name itself is the problem. Instead of “Tax-Free Savings Account”, it should have been named the “Tax-Free Investment Account” since it can (and should) be used to grow an investment portfolio where it will yield the greatest benefit.

When holding TFSA funds in cash or low-interest investments, people withdraw without a thought. When you have some in the younger categories averaging a whopping 7.16 withdrawals per year, it suggests they don’t understand the benefits. They’re likely holding for short-term purposes. This makes their TFSA barely any better than a chequing account.

How I Use My TFSA

I learned sometime in 2010 that a TFSA could hold stock investments. I’ve been using it to fuel my investment gains ever since. After all, I love when companies send me tax free dividends which I can then reinvest, all to buy even more stocks.

The TFSA is my primary shelter of choice when it comes to putting money away for the future. I love knowing that I will be able, at some point, to withdraw funds and get their full value without needing to pay tax (that tax is paid up front since contributions are not tax deductible).

A few examples of companies I have in my TFSA include the Bank of Nova Scotia (BNS), Canadian Pacific Railway Company (CNR), and Canadian Utilities (CU). The cash flow these churn off in the way of dividends is 100% mine to keep or reinvest.

Conclusion

The TFSA is a huge asset to Canadian investors. Being able to shelter investment income and let it compound for decades provides a huge boost to investment potential when you consider the impact of taxation over time on investments not sheltered.

Although the TFSA has been around for around a decade, there are still misconceptions as to how it can be used. This confusion is costing investors as they should be using it to let their investments compound without the erosion of taxation.

I hope to continue seeing the government increase the contribution limits as this is my favourite way to put money aside for the future.

Please be advised that I am not an investment or tax adviser and nothing in this article should be taken as advice. You need to do your own research and due diligence before making any decisions regarding your investments or tax planning.

Thank you for reading.

– Ryan

Full disclosure: Long TD, BNS, CNR, CU

Pictures courtesy of pixabay.com