When not to contribute to a TFSA

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Q: My wife and I would like to put our inheritance (approximately $80,000) into our TFSAs, which we have never used, to generate as much tax-free monthly income as possible.

Any tips, suggestions?

—Richard

A: Tax-Free Savings Accounts (TFSAs) are a good tool, but they’re just one of many available to most Canadians. When you’re in savings mode, Richard, it’s important to look at all options for each available dollar of savings and prioritize them accordingly.

A TFSA may be a great choice for one person, but a less appealing option for another. TFSAs aren’t necessarily the holy grail of investing, so don’t get preoccupied. Always consider all factors.

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Without full knowledge of your financial situation, Richard, it’s hard to say whether you should just plow your $80,000 inheritance into TFSAs. So I’ve compiled a list of five situations where you should consider NOT contributing to a TFSA to try to help.

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1. You are in a high tax bracket and you have Registered Retirement Savings Plan (RRSP) room available.

2. You have a group savings plan at work (group RRSP, defined contribution / DC pension, stock purchase plan, etc.) and there is a company matching contribution that you are not maximizing.

3. You have high-interest consumer debt like credit cards or unsecured lines of credit.

4. You are a conservative investor who will earn a low rate of return on your TFSA and you have a mortgage at a higher interest rate than your TFSA would likely earn.

5. You have minor children and you expect to fund their post-secondary education, but haven’t maxed out your Registered Education Savings Plan (RESP) contributions.

This list is hardly exhaustive but gives you an idea of some of the reasons to avoid TFSAs. If any of the above apply, I would be inclined to consider RRSPs, group savings plans, debt repayment or RESPs over TFSAs.

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If the above do not apply, TFSAs could be great tools for you and your wife, Richard.

As far as tips or suggestions, it depends on how you’re investing your money currently.

If you have an advisor, talk to them about starting TFSA accounts. See what they have to say and what they can offer. Adding $80,000 to your portfolio may push you past a certain threshold that gives you access to new investment options, lower fees, etc. It may also make your portfolio large enough to consider other third party investment companies that have minimum investment thresholds that you may not have met previously.

If you’re a DIY investor, consider how to rebalance your portfolio now that you will have these tax-free accounts at your disposal, Richard. I assume you don’t have non-registered investments if you haven’t opened TFSAs previously, which suggests you may only have RRSPs*. If so, U.S. stocks are probably better to hold in your RRSPs than your TFSAs, because the IRS levies a withholding tax on U.S. stock dividends in your TFSAs*, but not your RRSPs.

Compare the Best TFSA Savings Accounts in Canada* >

As you add cash to your investment portfolio, make sure you rebalance your overall asset allocation to your targets. Whether you add the cash slowly into the markets is a personal decision. Stocks rise about three-quarters of the time, so the odds support immediate investment over dollar-cost-averaging. But staggering into the markets reduces the risk of investing it all on the wrong day, if that’s a big psychological concern, Richard.

Last, but not least, consider your income and capital needs from these TFSA accounts. Are these long-term accounts that you won’t access for some time? Or will these accounts be drawn upon sooner rather than later for cash flow? Use the account timing to determine investment time horizon and your resulting risk tolerance – which can be different for different accounts, despite your overall risk tolerance.

Good luck with your TFSAs, Richard. They can be great tools, given the right circumstances and decision-making.

Ask a Planner: Leave your question for Jason Heath »

Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.

About Jason Heath, CFP

Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.

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