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TFSA Contribution Levels Raised

Jason Ayres
May 19, 2015
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Announced late April, but effective as of January 1st 2015, Canadians are now entitled to contribute $10,000.00 to their Tax Free Savings Account on a yearly basis, up from $5,500.00 last year. As of now, it makes the total contribution limit $41,000.00.

According to news sources, the Liberals are on record opposing this increase by the Conservative party and that they prefer the limit remain at $5,000.00. Depending on how Canadians vote comes election time, this bump in contribution limits may be short lived, but for now it’s worth taking advantage of.

TFSA’s offer a shelter from taxation on profits generated on after tax dollars. While taxes are paid on the capital before it is deposited, profits are free to grow, compound and be withdrawn without taxation.

While an RRSP offers the investor shelter from the immediate taxation of capital gains, tax will be paid upon withdrawal whereas profits from gains in a TFSA account can be withdrawn at any time and are not subjected to taxation.

Many investors are unaware that they can actually apply a number of option strategies in their registered accounts.

Since 2005, the following strategies have been permissible:

  • Buying calls as a stock replacement strategy
  • Buying calls to secure the purchase price of a stock you wish to own in the future
  • Buying puts to trade a bearish view
  • Buying puts for protection
  • Covered calls
While any of these strategies can offer the investor an edge over the traditional approach to managing their money, let’s consider the impact that the covered call strategy could have on the cash flow generated in a TFSA.
While stocks and exchange traded fund values may fluctuate up and down over the years, an investor implementing the covered call strategy could increase their non taxable income significantly.
Let’s assume that an investor is well diversified across multiple accounts and investments. $41,000.00 in a TFSA may be considered risk capital and the investor is prepared to be a little more aggressive with the objective of achieving a higher rate of return. Based on their analysis and expectations, they believe that Agnico Eagle Mines (TSE:AEM) is a good investment over the long term. Having a substantial amount of diversified investments in other accounts, a $41,000.00 stake in this company represents a small portion of their overall net worth.
With TSE:AEM trading at $40.29, the investor could purchase approximately 1,000 shares.
I want to make it clear that I am not recommending that investors allocate all of their TFSA to one security. Investors must consider their own personal circumstances and diversify their investments accordingly. That said, the covered call strategy could be applied to a basket of options eligible stocks spread across a number of different sectors. For the purpose of this example, TSE:AEM makes for an interesting consideration. While the share price has been quite volatile, the option premiums have reflected this and are paying the covered call strategist generously for taking on the obligation to deliver the shares. As of Friday May 15th, the stock is trading at $40.29. The June 2015 $42 call is bidding $1.15.
aem option chain
Selling this call against the shares of TSE:AEM obligates the investor to deliver the shares at $42 over the next 33 days. While the investor can profit on the shares by $1.71 if the stock rallies above the $42 strike, they have also generated $1.15 per share or almost 3 percent in cash flow. On 1,000 shares, this represents $1,150.00 of tax free income in 1 month.
It is important to recognize that the risk associated with the covered call strategy lies with the underlying stock. If the shares drop below the purchase price less any premium collected, the investor will be sitting with an unrealized loss. Further to that, by selling close to the money calls, the investor has limited the potential upside. Considering the risks, selling calls each month against the shares serves to mitigate the impact of a drop in the share price when an adverse move takes place. When the stock stays the same or increases in value, the investor has generated a respectable income on their investment. This cash flow can be withdrawn tax free to be used at the investors discretion, applied to the purchase of additional shares or simply left to build up the free cash reserves in the account.
This example represents a covered call return that is on the higher side due to the volatility of TSE:AEM. However, even on a diversified TFSA portfolio of options eligible stocks and ETF’s the compounding effect over the long term could result in a pretty impressive tax free return.
Jason Ayres
Jason Ayres http://www.croftgroup.com/

CEO and Director of Business Development

R.N. Croft Financial Group

Jason is CEO and Director of Business Development at R N Croft Financial Group, a member of the Croft Investment Review Committee and a Derivative Market Specialist by designation. In addition, he is an educational consultant for Learn-To-Trade.com and an instructor for the TMX Montreal Exchange.

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