During my last net worth update I commented on the fact my Tax Free Savings Account (TFSA) contributions are now maxed out which would mean I’ve contributed $25,500 in the last five years. That account balance at that time was $33,100 or a total gain of $7600 or 30%. The gains are big, but you have to keep in mind that my TFSA is my highest risk account. Unlike a lot of people who just put their contributions in savings account (paying 1% return which is so tragic waste of this accounts potential I almost weep when I hear it), mine is all invested in individual stocks.
So why is a savings account is a tragic waste of potential? Well let’s say you have maxed your TFSA ($25,500) in a high interest saving account at Royal Bank for a 1.1% yield. That would be a big old $280.50 in interest per year. Taxed at a marginal rate of 39%, you saved $109 in taxes. Not bad right?
In my TFSA, I buy stocks that mirror my bills since I’m interested in mature businesses that pay a good dividend or distribution. My current holdings are: AQN, BCE, D.UN, NPI, and REI.UN. In total these stocks pay me $1982 a year to hold them or if you compare that back to my contributions that is a 7.8% yield. That is a high yield, but like I said this is my high risk account, I would be insulted if I wasn’t being paid well for taking the risk. Now just on the distributions (39% marginal tax rate) and dividends (17.9% marginal tax rate) I save about $505 per year on taxes. Yet it gets better, I also save any capital gains taxes on anything I sell as well.
So it is safe to say I’m saving likely five times the taxes that people who have their TFSA in plain old savings accounts. So what’s the deal? Why do people use their valuable TFSA contribution room on just savings? Well, the TFSA title tends to confuse some people, but the other thing is people focus too much on their marginal tax rates. I’ve been asked several times why I’m putting dividend paying stocks in my TFSA since they think saving at your 39% marginal rate is better than a mere 17.9% for dividends. The issue is how much yield are you saving the tax on, even if you ignore the income trusts in my TFSA I’m still saving $226 per year on tax on just the dividends. I’ve got much more yield that even at a lower tax savings I’m still coming out ahead.
So the lesson for today is: don’t let the your marginal tax rate drive your investing behaviour, check the math when making investing decisions. So what do you have your TFSA account invested in?