Maxed Out TFSA: Now What?

Jake - Author/Founder

Jake - Author/Founder

Hi. I'm Jake. I believe you can build a wealthy life through frugal living and index investing.

I like to share helpful books on my blog. These are affiliate links, meaning I get a small commission at no cost to you if you click the link and buy a book. I only link books that I have read and found useful. 

You’ve been investing for a while, contributing to your TFSA, and you’ve reached the contribution limit. Now what?

First off, you’re doing great. You should be proud of yourself for spending less than you earn and investing. It sounds like you have good personal finance habits and systems in place.

If you were like me, you didn’t care about taxes on investment income until this point. But now, taxes matter. Now you have skin in the game.  Once your TFSA is maxed you have two options:

  1.  Invest in the RRSP; and/or
  2.  Invest in a taxable account.

By understanding how the TFSA works, how the RRSP works, and investment taxes, you’re set to maximize your after-tax wealth by locating investments in a specific way across your accounts.

This is called tax efficiency, and it is excellent, but it comes at the cost of complexity.

I’ll share my approach to a maxed TFSA.  Note that this post discusses TFSA use with stock and bond index funds. See this post for TFSA use with short-term savings.

Finally, there are cases where a TFSA can be maxed, and you still may not be ready to invest. Here are 9 Signs You Are Ready To Invest. 

Disclaimer

This info is for education only. It is not advice. I have an MBA and an engineering degree. Most importantly, I read a lot and have been managing my investments for 7+ years.  I am not a CFP or CFA. I am also not an attorney, although I feel like one when this. 

Please read my disclaimer page for more. 

Table of Contents

Step 1 - Determine Priorities - RRSP vs. Taxable

Now that your TFSA is maxed, there are two considerations:

  1. What account to fill next; and
  2. How to locate investments across the various accounts to reduce taxes owed.

For most, it’s best to fill the RRSP once the TFSA is maxed. There are a few cases where it can be useful to invest in a taxable account even when you have RRSP room. I’ll cover this rare circumstance below.

First, let’s cover the account priorities that will maximize after-tax wealth. There are three different possible situations.

The following account priorities is likely to maximize after-tax wealth if your tax rate today is lower than your expected tax rate in retirement. 

  1.  TFSA First
  2.  RRSP Second
  3.  Taxable Account Last

The following account priorities is likely to maximize after-tax wealth if your tax rate today is higher today than your expected tax rate in retirement. 

  1. RRSP First
  2. TFSA Second
  3. Taxable Account Last

Top 8 Books To Build Wealth

When You May Want to Prioritize the Taxable Account Before the RRSP

There are cases where it is sensible to fill your taxable account before your RRSP, like this:

  1. TFSA First;
  2. Taxable Account Second; and
  3. RRSP Last.

I’m in this situation right now. The TFSA is maxed, I have RRSP contribution room and I am investing in my taxable investment account with tax-efficient Canadian equities (using VCN).

I see two reasons why one may use taxable investments while still having RRSP room:

(1) Your tax rate today is far lower than your tax rate in retirement. Two sources of high retirement income are pension income, or investment income (from an RRSP or taxable investment account).

(2) You expect your income to increase significantly in the future and want to save RRSP contribution room for when your tax bracket is higher.

TFSA vs. RRSP vs. Taxable Comparison Calculator

I built this calculator to help me better understand how account selection affects after tax wealth. You can download an excel copy, or make it your own in google sheets. 

Step 2 - Understand Asset Location

Once you have the account priorities set, the next step is to place investments across the various accounts in a way that minimizes tax. This is called asset location.

Note that asset location is different from asset allocationAsset allocation represents your mix between stocks, bonds, and cash. Asset location speaks to the account location where you put your investments. 

So, how much tax can I save with asset location? Maybe a maximum of 0.5% annually over the long term. 

I will dig into the specifics of asset location in Step 4. But first, asset location comes at the cost of increased portfolio complexity. That’s why we will first look at the simple approach.

A Point On Simplicity

Before we jump into asset location, I want to talk about simplicity.

Asset location can be complex. For example, I use the complex method and have upwards of 5 ETFs spread between three accounts. This can be a headache. I only do this because investing is my hobby. 

Plus, some ETFs need to be in USD in the RRSP to reduce withholding taxes, adding complexity and costs of currency exchange. For example, Norbert’s Gambit can be used to reduce currency exchange fees.  

Plus, simplicity helps you leave your portfolio alone, making it easier to detach and protect yourself from human biases that hurt returns. It also preserves your most valuable resource – time. This way, you can focus on life rather than investing.

So, what is the most simple approach? For me, these would be an asset allocation ETF. 

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How to Maximize Simplicity: Asset Allocation ETFs

One-fund asset allocation ETFs remove complexity. With MERs around ~0.2%, these one-fund ETFs give low-cost exposure to a global collection of stocks and bonds. 

The equity (stock) component holds underlying index funds that cover U.S., Canadian, International and Emerging Markets. And they automatically rebalance to retain a target geographic exposure.

An asset allocation ETF of choice can be placed in accounts in the order described in step 1.

For example, if tax rates today are lower than expected tax rates in retirement, consider filling the RRSP once the TFSA is maxed. 

Asset location is no longer a problem with a one-fund approach. Plus, you don’t need to re-balance every year. Each account would be filled in accordance with Step 1. Under this approach, each account would have the exact same ETF and the exact same asset mix. 

Step 3: Asset Location, the Complex Approach

Asset Location Once TFSA is Maxed: Summary

I’ll start of with my approach once the TFSA was maxed. Then we will go into the “why”. 

Once the TFSA was maxed, I put tax-inefficient investment in the TFSA. I then placed my tax-efficient Canadian stocks in my taxable account.

I am unique because I don’t use the RRSP due to a defined benefits pension.

Securities I prioritize in my TFSA: 

  • International Stocks (XEF) 
  • Emerging Market Stocks (VWO) 
  • U.S. Stocks (VUN)
Securities I prioritize in my RRSP: 
  • Bonds (VAB)

Securities I place in my Taxable Account: 

  • Canadian Stocks (VCN) – Tax-efficient dividends that reduce tax drag on compounding. 

Investment Categories for Asset Location

Understanding how taxes apply to investment income empowers you to determine investment location. There are 6 separate categories of investments I like to think about separately for tax purposes:

  • Canadian Stocks – High Yield, tax-efficient if you make less than $150k/yr
  • U.S. Stocks –  Low foreign dividend yield. Tax-efficient.
  • International Stocks – High foreign dividend yield, tax-inefficient.
  • Emerging Market Stocks – High foreign dividend yield, tax-inefficient.
  • Bonds – High yield, tax-inefficient.
  • REITs – High yield, tax-inefficient.
 

Tax on Investment Income

We can now learn why the different categories of investment income are tax efficient or tax-inefficient in a non-registered (taxable) account. Finally, we can cover how withholding taxes impact foreign dividends. 

I cover taxes on investment income in this guide, including how taxes apply to capital gains, Canadian dividends, foreign dividends, and withholding taxes. 

A quick refresher. The three categories of income I look at for tax purposes: 

  • Other income includes employment income, foreign dividends, and interest income. Other income is taxed at your marginal rate – your highest tax rate. This type of income is tax-inefficient. 
  • Capital gains income – The difference between an asset’s purchase and sale price is capital gains income. Half of the capital gain (50%) is taxed at your marginal rate. Capital gains are tax efficient. 
  • Eligible dividends are dividends paid by Canadian companies and are taxed at low rates. Canadian dividends are tax-efficient, especially if your income is low. 

The chart below shows the combined federal and provincial tax rates for the three core income types for those in Ontario. 

Don’t live in Ontario?  You can find the combined tax rates for each province here.

Combined Federal & Ontario Tax Brackets and Tax Rates Including Surtaxes

2022 Taxable Income

2022 Marginal Tax Rates

Other
Income

Capital
Gains

Canadian Dividends

Eligible

Non-Eligible

first $46,226

20.05%

10.03%-6.86%

9.24%

over $46,226 up to $50,197

24.15%

12.08%-1.20%

13.95%

over $50,197 up to $81,411

29.65%

14.83%6.39%

20.28%

over $81,411 up to $92,454

31.48%

15.74%8.92%

22.38%

over $92,454  up to $95,906

33.89%

16.95%12.24%

25.16%

over $95,906 up to $100,392

37.91%

18.95%17.79%

29.78%

over $100,392 up to $150,000

43.41%

21.70%25.38%

36.10%

over $150,000 up to $155,625

44.97%

22.48%27.53%

37.90%

over $155,625 up to $220,000

48.35%

24.17%32.19%

41.79%

over $200,000 up to $221,708

49.91%

24.95%34.34%

43.58%

over $221,708

53.53%

26.76%39.34%

47.74%

This is not my chart. All credit belongs to taxtips.ca.

Withholding Taxes

Most people, like myself, focus on Management Expense Ratios (MERs). But the 15%  U.S withholding tax on dividends often generates even greater losses than ETF MERs.

Understanding withholding tax can save you up to 30 basis points (0.3%) annually for a portfolio of global stocks. This will equate to a 9.4% difference in portfolio value over 30 years. You cannot avoid withholding tax in a TFSA, but you can avoid US withholding tax in a RRSP. 

Read Justin Bender’s White Paper on Withholding Taxes to learn more. It’s the best resource on withholding tax for Canadians. If this paper makes your brain hurt, you’re not alone. It made my brain hurt too. It’s up to you to determine if the brain pain is worth the small gain.

Asset Location Wrap Up

 To understand asset location, you need to understand how taxes apply to the various types of investment income. You can read more about asset location in this PWL Capital White Paper.  

Step 4: Summary

This table summarizes how I locate my investments. Note that even the tax-efficient securities should be in the TFSA, not in a taxable account. 
 

Tax Efficient or Tax Inefficient?

Location

Notes

US Stocks (low dividend yield)

Efficient

Taxable Account

2nd priority in a taxable account

Canadian Dividends

Efficient

Taxable Account

1st priority in a taxable account

High Dividend Yield Foreign Stocks

Inefficient

TFSA, RRSP

RRSP can eliminate U.S. withholding taxes. 

Interest Bearing Assets (Bonds)

Inefficient

RRSP, TFSA*

RRSP priority 

REITs

Inefficient

TFSA

 

Taxable Account: Capital Gains or Canadian Dividends?

We know capital gains and Canadian dividends are the most tax-efficient in a taxable account. But how do we decide which one to prioritize?

Here are three things to consider when pondering capital gains income and Canadian dividends in a taxable account:

  • Eligible dividends become are more tax-efficient than realized capital gains once you start making over ~$100k/yr in taxable income. After this point, realized capital gains are more tax-efficient relative to dividend income. The exact threshold depends on your province. Reality is that you likely won’t realize capital gains until far in the future. 
  • Dividend taxes impose a minor tax drag on the compound effect that can have a large impact on portfolio value over time. I show this effect in my post on S&P500 Dividends. Capital gains don’t have this problem as they grow tax-free until you sell (and realize the capital gain). 
  • Your taxable income increases by 1.38% of the dividend received (the gross-up amount). This will increase taxable income and can take you into a higher tax bracket.

Including The RRSP

I expect to be in a higher tax bracket in retirement (government pension + taxable investments) relative to my current tax bracket, I only use the RSP to hold bonds.

I’ll sell the bonds when I buy a home under the Home Buyer’s Plan, when I personally find it makes more sense to own rather than rent.

Holding bonds in the RRSP also leaves more room for assets with higher expected returns in the TFSA. A larger TFSA account value down the road can provide tax-free income, whereas all income pulled from the RRSP will be taxed as regular income. I will maximize after-tax wealth by holding assets with higher expected returns in the TFSA. 

If I held stocks in my RRSP, I would prioritize my U.S dividend-yielding ETFs, to reduce withholding taxes. With a low U.S. dividend yield of 1.3%, I would only save 0.2% per year in U.S. withholding taxes. 

Other Considerations

Changes To Future Tax Rates

There is always a risk that tax rates will change. Under the baseline situation, the can be expected to increase with inflation. But I’m talking about inflation-adjusted rates changing. 

You can consider this a risk when doing your planning. 

Captial Gains vs. Dividends

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A Final Note: Be Cautious With Complexity

We all have a unique tolerance for investment complexity. I suggest you consider the amount of work your willing to put in for a given gain in tax efficiency. Keep in mind that greater portfolio involvement increases risk of behavioral errors.

You can check out various model portfolios at Canadian Portfolio Manager. This blog has various portfolios with differing levels of complexity. I’d own a single asset allocation ETF in all accounts if investing wasn’t my hobby. 

It is easy to get caught up in these complexities. Tax efficiency will give you a slight edge when growing wealth, but it is far less important than sustaining the behaviors that permit consistent saving and investing.

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