Thursday, 3 December 2015

TFSA dividends spent wisely - why not put them into an RRSP?




An idea occurred to me the other day.  The news kept talking about the TFSA limits next year and how it was going to revert back to $5,500.  As Justin Trudeau's government finalizes all the new taxes and everything else that comes with running a government.  Now opinions will vary of course but there seems to be a growing community of knowledge investors out there supporting the idea that the TFSA is more valuable than the RRSP.  This is of course a topic I can comment on but not today.  While thinking of the TFSA, I thought about the dividends.  The general consensus seems to be that you keep your money inside a TFSA and any capital gains and dividends are tax free.  Correct.  But if the dividends are tax free, what do you do with them?  DRIP them?  you could do that but I am already doing that in my entire RRSP portfolio.

So what to do with these tax free dividends.  Can we withdraw them and use them to buy things, why of course you can, again the general consenus is to use this money for emergencies or a giant screen tv.  Sounds great, but why not use these dividends to pay for some of your RRSP contributions?  Yes you know how some people contribute monthly into their self directed account or they lump sum the amount at the beginning or end of the year.  Well can these tax free dividends be used to reduce that amount?

We start off by assuming that you have the Savings Account TFSA that really pays a savings account rate of like 0.5% or something like that (this rate is what BMO is currently offering).  This is very low.  So if for example, you have $20,000 (this is an average amount given you started in year 1 of the TFSA and you did not max out)  in your savings account TFSA.  That will preserve your initial investment of $20,000 yes, but you will earn $100 a year on this $20,000.  This is really not enough to spend on an emergency or flat screen TV.  you get this amount dividend by 12 months if lucky so you get $8 a month if you are lucky enough they pay monthly.  Everyone talks about the cost of living or inflation some call it.  The most recent cost of living for 2014 is 2.5%.  You are going backwards with your $20,000.  Your $100 is eroded by the cost of living and guess what else, the bank makes money on your $20,000 so they love you.

So Peter, what are you talking about spending the TFSA dividends wisely?

Here comes my example.  First off, you have to sign up for the self directed TFSA that I have discussed in previous posts.  Again read the description of what you can put in a TFSA, mutual funds, stocks, GICs, bonds, etc.  So why does the bank keep promoting a freaking savings account?  They know that that product makes the most money for them.  Once you sign up for the self directed TFSA account, you transfer the $20,000 from the savings account TFSA to your self directed TFSA similar to the RRSP example I did in my BIG BANG post.  Now you control everything, what you buy, how much, etc.  My example we will use BCE.  This stock is considered by many to be blue chip stock and is as low volatile as you can get yet they have a very good yield.  Currently BCE is yielding 4.5% at at stock price of $57.00  What does this mean?  For those who like math, here we go.

Buy 350 shares of BCE at $57.00 for a total of $19,950.  There will be the commission fee of $9.99 for most accounts so you have $19,959.99 taken out of cash and used to buy BCE.  That's all you pay for to buy.  You only need to pay that $9.99 again if you sell.  But that will be far into the future.  No ongoing MERs, nothing.  Now it's just the stock price going up and down and more importantly, the dividends.  Like I said, this is a good stock but it will go down or up, but historically it's all up as BCE is a very large company, Bell cell phones, Bell television, Bell internet, sports, etc.

So now BCE will pay you $0.65 for each share 4 times a year if you do not activate the DRIP.  Let's see, that's $227.50 each quarter or $910.00 a year.  This amount is as close to guaranteed as you could get as there are thousands of investors across Canada getting the same dividend, $0.65 a share.  Wait a minute Peter, you are telling me instead $100 a year, I can get $910 a year with the same $20,000.  Yes you can, and also if you listen to the news, and do your homework, you will notice that BCE raises it's dividend once a year for almost 30 years straight now.  So what happens if they raise their dividend to $0.67 year which is a modest 3% and very reasonable for BCE to do, instead of $910 you get $938.

Now do not DRIP this amount, instead withdraw it from you self directed TFSA and put right away into your self directed RRSP.  Now you have tax free dividends helping you pay for your annual RRSP contribution.  If you decide to contribute say $8,000 for 2016.  now you only need to contribute out of pocket, about $7,000 as you will get $900 from your TFSA.  You get your RRSP receipt at the end of 2016 for $8,00, file your income tax return.  Get refund. Done.

Now I still love deferring my taxes through the RRSP.  They say if you know that your highest tax rate is now and you know you will be in a lower tax rate later than the RRSP is the way to go

Comments and remarks on the above example are always welcomed.

Thanks for reading.

Peter