In Canada, you can hold several different types of investments in your tax-free savings account (TFSA). Once it’s within your contribution limit, almost anything is okay in the eyes of the Canadian Revenue Agency (CRA). Stocks, bonds, cash, GICs, or anything the investor deems reasonable—with some exceptions—is suitable for a TFSA. This gives investors a broad range of options for funding these tax-free accounts.
An investor can place a bond or other investment vehicle into a TFSA once it is listed on one of the six Canadian or 41 foreign stock exchanges accepted by the Federal Department of Finance. You can even place a delisted stock into your account, but only if it’s a Canadian equity. You can also hold private shares, but TFSAs have some special rules that make holding these investments potentially less attractive.
For instance, if you received the shares due to an exercisable stock option, they will be taxed on the difference between the shares’ fair market value and their exercise price. In addition, you must watch these holdings closely. They can be subject to CRA penalties if the percentage held by the individual and related parties surpasses 10% of the equity of the private company.
Of course, you can put cash into your TFSA, but it raises a critical issue regarding appropriate investments, and what should be placed in a tax-sheltered account. Bank of Montreal conducted a survey in 2013, which found that Canadian investors were holding 57% of assets eligible to be placed in a TFSA in cash; 25% were held in mutual funds, and only 14% were in stocks.
This allocation, according to financial experts, is the exact opposite of what you should be holding in your TFSA account, especially if you’re younger than age 40. One of the advantages of TFSAs is that they allow investors to accrue investment returns, through capital gains and dividends, without being taxed, and investors should keep this in mind when deciding on asset allocation for their TFSAs.
It makes little sense to hold cash, which at present attracts less than 0.5%, and which takes up valuable contribution space, especially when one considers how cash loses money through inflation. Investors are better served by placing stocks that are likely to spin off high rates of return or quarterly dividends and future capital gains in the TFSA, since these gains accumulate tax-free.
For younger investors, TFSA returns can be allowed to compound for decades. $5,000 would be worth $8,235 within a decade. Time is your friend when it comes to this type of investment: it grows exponentially every year that you hold it. However, if your stocks are iffy, and you’re likely to lose some capital gains—it would be better to hold these outside of your TFSA.
The rules governing TFSA allow you to be flexible in developing a portfolio within the account. On the other hand, you need to be vigilant and monitor your account in order to ensure the best returns on your investment.