What is a Self-Directed TFSA & How Does It Work?

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Danielle Kubes is a trained journalist and investor who has written about personal finance for the past six years. Her writing has been published in The Globe and Mail, National Post, MoneySense, Vice and RateHub.ca. Danielle writes about investing and personal finance for Wealthsimple. She has a Bachelor of Humanities from Carleton University and a Master of Journalism from Ryerson University.

A tax-free savings account, or TFSA, is an investment account in which your money grows tax-free. Anyone who is 18 years of age or older and has a social insurance number (SIN) can open a TFSA. A self-directed TFSA is one in which you pick and manage investments yourself.Usually, the bank or the TFSA issuer invests money in a TFSA for you. For instance, a mutual fund TFSA account lets you choose which mutual funds you want to invest in, but it is managed by professionals.A self-directed TFSA gives you complete control of your investments. You can buy and sell investments of your choice to build your own unique portfolio.The biggest advantage of a self-directed TFSA is that your money grows tax-free for life. You don’t have to pay taxes or penalties on withdrawals. You can withdraw from your self-directed TFSA at any time.

What investments can go into a self-directed TFSA?

A TFSA can have a variety of investments such as:

  • Cash

  • Bonds

  • Stocks traded on recognized public exchanges

  • Mutual funds

  • Exchange traded funds (ETFs)

  • Guaranteed investment certificates (GICs)

Can you transfer investments into a self-directed TFSA?

Yes, though it depends on the type of account from which you are transferring those investments.

From a Non-registered brokerage account

If you are holding securities such as stocks and bonds in a non-registered brokerage account, you can transfer them into a self-directed TFSA after paying capital gains taxes.Because the capital gains in a non-registered brokerage account are subjected to tax, they will be taxed at the time of transfer into a TFSA. Once the amount is moved to your self-directed TFSA, you can enjoy tax-free capital gains.

From an RRSP

There is no way to send your RRSP funds to a self-directed TFSA directly. Investment in your RRSP account grows tax-deferred, meaning that whenever you withdraw funds, you must pay taxes.To move your investment from an RRSP to TFSA, you’ll have to withdraw from your RRSP, pay taxes and penalties on the amount and then contribute to your self-directed TFSA. A wiser option may be to not withdraw any amount from the RRSP and in the future start contributing to your TFSA instead.Your investment in a self-directed TFSA is tax-free for life which means that all interest, dividends, and capital gains earned in your TFSA will be tax-free. You can also withdraw such funds at any time without having to pay taxes.

From another TFSA

Transferring funds from one TFSA account to your other TFSA can usually be done without any tax consequences.

Commissions and fees charged on self-directed TFSAs

Before you open a self-directed TFSA, you should be mindful of the fees associated with maintaining a TFSA:

  • Banks or financial institutions charge an annual maintenance fee on a self-directed TFSA. Some banks only charge maintenance fees if the balance of your TFSA is below their minimum requirement.

  • You pay a money transfer fee each time you transfer money into your self-directed TFSA account.

  • There is also a commission on trading stocks in your TFSA. Most banks charge a flat fee of $9.95 per stock trade.

  • If you transfer your TFSA from one financial institution to the other, you’ll have to pay transfer fees. Most banks and financial institutions charge a transfer fee between $50 to $150. Wealthsimple does not charge transfer fees. Even if you transfer to Wealthsimple TFSA, your fees are reimbursed if assets in your TFSA are worth $5,000 or higher.

Advantages of self-directed TFSA accounts

Lower fees

TFSAs invest in mutual funds because they provide exposure to several stocks at once, which diversifies risk. But mutual funds are actively managed by industry experts who charge an annual fee for their efforts, known as the management expert ratio (MER), which is usually somewhere between 1.5% to 3%. Although these fees may not look like a lot at first, they can be detrimental to capital gains in the long term.Self-directed TFSAs allow you to pick your own investments so that you can choose the ones with lower fees, such as ETFs. However, they are passively managed, and the average ETF fee is around 0.53%. Investing in ETFs instead of mutual funds can result in considerably lower fees.

Higher returns

By lowering fees, you can make a significant difference in your total investment growth. Lowering the fees from 2.5% that you’d pay on mutual funds to 0.5% for ETFs dramatically changes what your investment earns in a year.Management fees are destructive to investment growth. When you are building your own portfolio, you can select options that do not involve high fees. Switching from mutual funds to ETFs can help you maximize returns by lowering fees.

Unique portfolio

When you are actively managing your own investments, you can choose to take an investment approach that suits you. TFSAs run by financial institutions generally invest in low-risk investments that also pay lower returns. You can choose to take on a more aggressive approach or stick with a reserved approach that you can switch any time.You won’t be restricted to choosing only what your TFSA issuer offers—you can invest in any qualifying investment.Self-directed TFSAs are intended for those investors who want to invest freely and create their own unique portfolios.

Disadvantages of having self-directed TFSA

Added risk

Buying individual stocks—especially the wrong ones!—can expose you to high levels of risk. Over time your investment may not perform as it could have performed if it was run by professionals. Investing in mutual funds and ETFs is generally considered a safer option because it helps you diversify your portfolio. However, mutual funds often come with high fees that will be counterproductive to investment growth. If you are new to investing, you will be taking on extra risks by choosing a self-directed TFSA.

Time-consuming process

Although managing your own investment can be exciting, it can be very time-consuming. Managing your own portfolio means that you must regularly monitor how the markets are performing and take investment decisions from time to time. Because markets are constantly changing, speculation can become overwhelming.If your lifestyle does not allow you to spend a lot of time on investing, a managed Wealthsimple TFSA account might be the right option for you. The standard management fee for a managed Wealthsimple TFSA is only 0.5%, which drops to 0.4% if you have over $100,000 in your TFSA.

Losses cannot be claimed

Taking on a more aggressive approach with your self-directed TFSA may not be the best option. If your individual stocks result in capital losses, you cannot claim them on taxes. Therefore, having a non-registered brokerage account might be better if you want to trade individual stocks with a high-risk profile. With a non-registered account, you have to pay taxes on capital gains, but you can also claim capital losses on your taxes.

Alternatives to a self-directed TFSA

Self-directed TFSA vs TFSA

The alternative to a self-directed TFSA is purchasing a TFSA investment product from a financial institution. Financial institution-run TFSAs and self-directed TFSAs are very similar. The only difference is that you have complete control over where your money is invested in a self-directed TFSA.

Although most TFSAs run by financial institutions invest in GICs and mutual funds, they come with significantly lower risk. The list of mutual funds offered in TFSAs managed by financial institutions is typically narrow. So, you do not have much control over where your cash is invested.

But with a self-directed TFSA, you can choose not only mutual funds but also ETFs or any other qualifying investment from a far larger range of options.

Returns in each year may swing wildly in either direction, but over the long term, it should balance out, and almost certainly grow more than cash. This is why the self-directed TFSA account is for investors who want to build an aggressive portfolio that is successful in the long run.

If you have enough contribution room, you might want to have more than one TFSA account. In addition to having a financial institution run TFSA, you can also have a self-directed TFSA account as there is no restriction on how many TFSA accounts you can have. Contributing a different amount to TFSAs every year will keep the investments growing separately. But more than one account also means paying fees for multiple accounts, therefore a consolidated TFSA account may be the wiser option.

Depending on your risk tolerance and investment goals, you can choose a self-directed TFSA account that gives you complete control of your investment portfolio, or a TFSA managed by professionals that have minimal risk.

Wealthsimple TFSA accounts are managed for you for only a fraction of what big financial companies charge.

Self-directed TFSA vs RRSP

If you are in a higher tax bracket, contributing to your RRSP will help you lower your taxes. But if you would like to have an additional income stream during retirement or in the future, contributing to your self-directed TFSA is a smart option.

TFSAs are more flexible compared to RRSPs. You don’t have to pay taxes on TFSA withdrawals, and you can withdraw from your TFSA whenever you like. Withdrawing from your RRSP will result in taxes and penalties, except in the cases of the Home Buyer’s Plan (HBP) or Lifelong Learning Plan (LLP).

At 71, you must withdraw from your RRSP. But there is no restriction on when you can or cannot withdraw from your TFSA. TFSAs and RRSPs have their own benefits. But if you would like to retire early or save for a house or a vacation, you may want to consider investing in a TFSA because you will be able to withdraw any amount tax-free from your TFSA whenever you like.

How to open a self-directed TFSA

Financial institutions, credit unions, banks, and insurance companies offer self-directed TFSA. To open your self-directed TFSA, you need to provide your social insurance number (SIN) and date of birth. You might also have to provide other supporting documents.

To open a Wealthsimple tax-free savings account, sign up online within 5 minutes.

Frequently Asked Questions

TFSA withdrawals do not count as taxable income. The TFSA grows tax-free and TFSA withdrawals are tax-free for life. However, if you are holding stocks of U.S companies in your TFSA, you’ll have to pay tax to the IRS on dividend income received from them.

Generally, TFSAs are tax-free even when you withdraw your income. However, you may have to pay taxes on income earned in a TFSA in the following situations:

  • Your tax-free savings account was not registered.
  • You held U.S stocks and received taxable dividends. In that situation, tax must be paid to the IRS.
  • You over-contributed to the TFSA.

To grow money in your TFSA, you need to invest in low-risk investments such as mutual funds, GICs, or other investment options that pay good interest or dividends. Utilizing the maximum contribution limit, you should invest the maximum amount every year to benefit from compounding.

The longer you keep your money invested in your TFSA, the more your investment will grow. Therefore, you should contribute earlier to give your savings more time and potential to grow.

If you plan to withdraw funds from your TFSA within the next 3 years, the managed TFSA with Wealthsimple lets you invest your cash in a high-interest savings ETF that pays monthly dividends.

Last Updated July 20, 2022

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