Benefits Of TFSA vs. Non-Registered Account

Experts have long recommended that investors set up their portfolios to be as tax efficient as possible by utilizing both registered and non-registered accounts.  This is referred to as portfolio allocation, and is meant to view all of your investment options, types of accounts, and the tax consequences for your returns.

Investors were ideally supposed to place interest paying investments inside their RRSP, since they are fully taxable outside of a registered account.  And because of the dividend tax credit, investors should hold Canadian dividend stocks in a non-registered account.

But then along came the Tax Free Savings Account and everything changed.  Canadians 18 years or older can save up to $5,000 a year tax-free, and unused contribution room can be carried forward indefinitely.  Cash, stocks, bonds, GICs, and mutual funds are all eligible contributions.  You can withdraw money at any time in any amount without being taxed, and re-contribute the full amount on a yearly basis.

Benefits of TFSA vs Non-Registered Account

Investors are not taking full advantage of the TFSA at this time, with most individuals just parking their money in a high interest savings account.  They also continue to believe that their Canadian dividend growth stocks are better off in a non-registered account.  But with the potential for tax-free growth inside the TFSA, investors may be wise to re-think their strategy.

Not only will their Canadian equities grow tax-free, foreign dividend paying stocks are also free of Canadian taxation (with the exception of the U.S. 15% withholding tax).  And for seniors, any TFSA withdrawals in retirement is not considered income, therefore not affecting eligibility for government benefits such as Old Age Security.

The only drawbacks I see in the TFSA vs. non-registered account debate is that you cannot claim a capital loss for any investments held within your TFSA, and the annual contribution room is quite small ($5,000) for those investors who want to convert their non-registered portfolio into a TFSA right away.

Portfolio Allocation

A high interest savings account shouldn’t be held in your RRSP or TFSA just to be tax efficient.  Remember that many years ago you could get double-digit interest rates on GIC’s and savings accounts.  Not anymore.

Shouldn’t investing be about maximizing your returns, not your tax efficiency?  For individuals who have maxed out their RRSP contributions, or have a defined benefit pension plan with very little RRSP room, the Tax Free Savings Account is a great vehicle to use for investing in stocks and REIT’s.

Conventional rules of portfolio allocation are also being tested as older investors start to recognize the benefits of using the TFSA as part of their overall retirement plan.  For younger investors, the small annual contribution room is not as much of a factor since their time horizon is much longer.  The tax-free growth compounds over time, and will not be considered income when withdrawn in retirement.

Personally I do not have a non-registered account, instead choosing to maximize my TFSA with Canadian dividend paying stocks and REIT’s.  This makes sense for my situation and for my retirement goals.

I hope that individuals do the math for their own situation when choosing investments, rather than relying on old rules of thumb about where their investments should be held.

Who wins the battle between the TFSA vs non-registered accounts?

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  1. Sustainable PF on December 22, 2010 at 9:47 am

    Great comments on the registered accounts.
    We keep bonds and foreign equities in our RRSP, REITS and cash holdings in our TFSA and then assuming we have no more space in those Canadian dividend payers in our non-registered account. Also, we practice the Smith Manouevre so those dividend payers are non-registered for the friendlier tax purposes and so we can use the dividends to more quickly pay off our mortgage and transform it into a tax deductible loan.

  2. SophieW on December 22, 2010 at 11:16 am

    Such a timely post!

    One of my goals for 2011 is to start my own dividend portfolio, but I’m still in the learning phase. I have a DB pension so the TFSA is where I want to place those stocks but it’s much more complicated than that.

    It seems I have to decide whether to make use of either DRIP and SPPs in a non-registered account and pay taxes on the dividends, or synthetic DRIPs and pay brokerage fees in the TFSA. I don’t know which would be more efficient.

    Like I said, lots to learn still…

    • Echo on December 22, 2010 at 12:12 pm

      Thanks for your comment. Good for you to get started investing in your TFSA, it will be a great complement to your DBP.

      I don’t have any DRIP’s set up, I prefer to let the dividends accumulate and then when I have enough to buy a worthwhile amount, I’ll purchase a new stock or add to a current position.

      Good luck getting started!

  3. The Passive Income Earner on December 23, 2010 at 11:44 am

    TFSA is a gem. I mostly buy dividend paying stock and they happen to be in my RRSP and TFSA accounts. Quite a small portion in my RRSP though since I contribute through my employer and it’s mutual funds.

    I have non-registered dividend investment through Computershare and CIBC Mellon because they don’t have the registered account support.

    I don’t apply specific rules for my TFSA just because I don’t pay tax on it. It’s the same rule in and out of my TFSA. My goal is to bring in good dividends from my investments and my TFSA gives me a higher return without the taxes.

    • Echo on December 23, 2010 at 12:09 pm

      Sounds good to me, I have the same philosophy and can’t understand why most people don’t take full advantage of their TFSA by investing.

  4. stu on January 24, 2011 at 8:26 pm

    One strategy I like is holding hi-yield former trusts in our TFSA’s and withdrawing the div’s monthly for income as we’ve been retired now 4years or so. This helps with our household expenses and adds to next years allowable contribution which will increase a little more each year. We added about $850 extra to each of our TFSA’s plus the $5000 each for 2011 for a total of $11700 for both accounts. I do this by transferring stocks from our taxable acct (in kind-no fees) to our TFSA’s. Eventually we’ll have emptied all our Taxable acct holdings into the TFSA’s. I know some will say you don’t get to use the dividend tax credit this way but I’d rather pay no tax at all than pay a reduced tax. I’m keeping the Reits in our taxable acct till the last as they’re taxed less than regular dividend stocks due to return of capital. This is the best strategy I’ve been able to come up with so far but I’m always open to a better idea.

    • Echo on January 24, 2011 at 8:51 pm

      Hi Stu, that sounds like a really good plan. Way to adjust your strategy on the fly as new investment options become available. This is a good reminder to always keep your options open as you never know what the government will do down the road. Change is inevitable.

      Thanks for sharing your strategy.

  5. Brian Poncelet, CFP on April 24, 2011 at 9:38 am

    You can have the same benefits as a TFSA and more with the right insurance.

    If you get sick or have a disability will your TFSA be funded up to age 65?

    If you take money out and repay yourself will the account be treated as if you never took any money out if you drain the TFSA for years?

    Can you make the TFSA tax deductible?

    Can you have guarantees of a death benefit or cash values in the millions?

    Drop me a line and I send you a book.

  6. Sam on July 12, 2011 at 5:43 am

    I have generally only used TFSAs for collecting dividends and that has been working out well.

    The only concern is that you cannot claim any form of capital loss with TFSAs, which means that it is only a suitable account for blue chip investments.

    As with anything, TFSA have their pros and cons and are great when used smartly.

  7. youngdividend on February 25, 2012 at 2:13 pm

    Great article, I hope I could get a response. I currently own three stocks in a non registered account through computershare and CST. The reason why I chose to do it though transfer agents was because I was able to contribute anytime without paying commission fees. Plus i was going to get Partial shares as opposed to whole shares you get with a rrsp or tfsa. My strategy was to build enough shares to put in a tfsa so I can compound my DRIP and not pay tax afterwards. Also, I realized because ihold those stocks in a non registered account, I will have to declare them on taxes. So do all my dividends get taxed? Would i potentially be losing money to tax on my dividends? if you could answer this it would begreatly appreciated

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