The money machine

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  By Guest Blogger Sinan Terzioglu

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According to the Canada Revenue Agency, the average unused contribution room for Tax-Free Savings Accounts (TFSAs) stood at $43,024 as of 2021. For those aged 35-39, the average was $54,430, and for those 40-45, the average unused room was $54,090. Fewer than 10% of TFSA account holders, across all income levels, have fully utilized their cumulative contribution limits. Surprisingly, among those with incomes of $250,000+, less than 30% have taken full advantage of their available room. Far too many are overlooking the significant benefits of this incredible account.

The TFSA was launched in 2009. A Canadian resident who was 18 years old at that time and has continuously lived in Canada without contributing to a TFSA now has $95,000 of available contribution room so a total of $190,000 for couples. One of the key advantages of TFSAs is the tax-free status of withdrawals and the ability to recontribute withdrawn amounts the following calendar year. This flexibility makes the TFSA an incredible account for long term retirement savings, however, to fully maximize the potential its crucial to begin contributions early on and stay invested for the long term.

Common reasons why many individuals with the ability to contribute and/or increase their TFSA contributions choose not to:

Spending too much on vehicles – It always amazes me to see so many high-end luxury vehicles and expensive SUVs on the streets of Toronto, especially knowing most are not taking full advantage of their TFSA contribution room. According to Ratehub.ca, the average monthly cost of owning a vehicle in 2024, which covers expenses like gas, parking, insurance and maintenance, totals $1,387 – so over $16,600 per year. If you don’t have a fully maxed out TFSA your monthly vehicle cost should not exceed your monthly TFSA contribution. Most don’t realize how much their $75,000 vehicle is really costing them. By reducing vehicle expenses by $500 per month and allocating the savings to a TFSA, one can significantly improve their financial position over the long term.

Financially stretching to purchase real estate – In many regions of the country, the cost of renting a residence is significantly lower than that of homeownership. Many, especially those in their 20s and 30s, should avoid stretching financially to purchase a home and embrace renting instead.

Example – Consider a 35 year old couple earning $75,000 each with $200,000 available. They are trying to decide if they should purchase a property for $800,000 or rent a similar property and invest their capital in their TFSAs instead. Purchasing would require a downpayment of at least $160,000 plus closing costs and land transfer taxes. The monthly mortgage payment would total approximately $3,800 but after adding maintenance, property taxes and insurance the monthly cost would total at least $5,000. This doesn’t even include the opportunity cost of tying up their capital.

Spending $5,000 per month would equate to over 50% of this couples total annual net household income. Shelter costs should not exceed 35% of a households total income. Purchasing the property would result in a lot less financial flexibility for this couple as they would have over $600,000 in debt and a lot less cash flow to save.

Alternatively, this couple can rent a comparable property for $3,500 per month and invest $190,000 in their TFSAs. If they contribute $14,000 per year to their TFSAs and earn an average annual rate of 6% the combined total of their TFSAs would be over $1.6 million after 25 years. This amount would comfortably provide tax-free income of $60,000 per year so in addition to government benefits they would have a strong financial foundation for retirement.

The bottom line is this couple cannot afford to purchase a property in the $800,000 price range while also building long term financial security. Renting not only provides them with more flexibility now but also sustained financial flexibility and more options in the future.

Inefficiently withdrawing funds from corporations – The recent increase of the capital gains inclusion rate within corporations highlights the importance of tax-diversification. Many business owners have been making the mistake of accumulating most of their assets in their corporate accounts while investing significantly less in personal accounts like TFSAs and RRSPs. Some with corporate accounts are unaware of the balances in notional accounts such as the Capital Dividend Account (CDA) and the Refundable Dividend Tax on Hand (RDTOH). As a result, they have been overlooking opportunities to distribute funds from their corporations in a tax-effective way and failing to capitalize on the full potential of their TFSA contribution limits.

Many active business owners only pay themselves in dividends because they believe they pay less total tax but because the Canadian tax system is integrated the combined personal and corporate tax an individual pays is essentially the same whether they receive dividends or salary. However, paying a salary earns an individual RRSP contribution room which if contributed to can result in tax refunds that can be used for TFSA contributions.

Avoid Gamblers Ruin

The Globe & Mail recently started a new series called TFSA Trouncers and highlights Canadians that have amassed large TFSA balances. In a recent article, the Globe featured a 50-year old massage therapist named Jacob and how he built up a $1.8 million TFSA and a $6.4 million RRSP.

Jacob’s portfolio started to take off in 2016 after he invested a large portion of his assets in cannabis company Canopy Growth Corp. and sold his shares in August 2018 netting him a large gain. He repurchased the shares in October 2018 and continued to hold them as the stock peaked in 2019 but after the stock dropped he lost hundreds of thousands of dollars. Jacob borrowed $300,000 from a home-equity line of credit to invest in two other cannabis companies that dropped significantly in value costing Jacob $600,000, including the borrowed money.

Currently, 90% of Jacob’s portfolio is invested in just one stock, MicroStrategy (MSTR), which is one of the largest corporate buyers of bitcoin. Over the last year MicroStrategy is up over 360%. Clearly luck is once again on Jacob’s side but his investment strategy puts him at significant risk of gamblers ruin.

While its inspiring to hear about other peoples investing success, it’s important to recognize the difference between a prudent investment strategy and gambling. TFSA contribution room should be handled very carefully because losses incurred in a TFSA results in lost contribution room and the losses cannot be used to offset capital gains in taxable accounts in the future. To build a substantial balance in your TFSA over time, it’s not necessary to take excessive risks. All you need is consistent saving, diversified growth assets and patience.

Sinan Terzioglu, CFA, CIM, is a financial advisor with Turner Investments, Private Client Group, Raymond James Ltd.  He served as vice-president of RBC Capital markets in New York City and VP with Credit Suisse in Toronto.

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