TFSA Account

What investments make sense to hold in your TFSA (Tax Free Savings Account)?  Generally, those with the highest taxes make the most sense to shelter in this account.  Referring to your marginal tax rate in the earlier post would tell you what type of earning is taxed the most.

But the tax rate is not the only factor - the absolute savings can also come into play.  Say you can earn 2 % in a 5-year term GIC.  Interest is taxed as Other Income which has the highest marginal tax rate, so putting it in your TFSA would seem like a good idea since you could reduce taxes by 20% for low income earners (reduce taxes by 0.4 % in an absolute sense).

But say you also hold a private REIT earning 8% and distributed as return of capital (i.e., no taxes).  Even though the tax rate is low (0%) it may be better to hold this in your TFSA instead - although the current tax rate is 0%, you would eventually reduce taxes as capital gains when sold at a rate of 10% - an absolute amount of 0.8% in the investment.

Its easier to see with example numbers:

Investment Type       GIC                    REIT
Earnings Type           Other Income      Return of Capital
Earnings Rate           2%                      8%
Marginal Tax Rate   20%                    0% (today), 10% as capital gains when sold
Absolute Savings       0.4%                   0.8%

So the REIT may be taxed at a lower rate (now and when sold) but may provide the greater absolute savings.