How to build a $1-million TFSA

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TFSAs are your ticket to a tax-free $1-million.

A small number of investing pros have already built tax-free savings accounts worth roughly $1-million, but the TFSA program is too new for the average investor to be anywhere near that. Patience and perseverance will fix that.

A 30-year-old who starts at $5,500 and makes the maximum annual contribution for the next 40 years could retire with a $1-million TFSA. A 40-year-old who already has a sizeable TFSA won’t make it to $1-million without a lot of ace investing moves, but $500,000 is certainly doable. See for yourself by trying The Globe and Mail’s Million Dollar TFSA Calculator.

Introduced in 2009, TFSAs have already become a great Canadian institution. It's simplicity that sells the TFSA. Once money goes into one of these accounts, it's off limits to the Canada Revenue Agency. Your investment gains are tax-free, and so are withdrawals. But as much as we've latched onto TFSAs as in indispensable investing and saving tool, we may be under estimating their potential to create massive amounts of tax-free wealth.

There are implications here for a federal government that is struggling with deficits in the near term thanks to an underperforming economy and faces the long-term challenge of an aging population that will slow future growth. We may reach a point where Ottawa has to contain the growth of TFSAs to generate more tax revenue and address issues of tax fairness arising from people paying no tax on their $1-million accounts. For now, though, TFSAs are a surer bet than the lottery as a route to a tax-free $1-million.

Canada Revenue Agency says there were 11.7 million TFSA holders in 2014, up from 4.8 million in 2009. In monitoring the balances in these accounts, CRA has found some in the million-dollar range. "In 2014 for example, significantly less than 0.1 per cent of the TFSA population had a fair market value of $1-million or more," a CRA spokesman said via e-mail. "This number has been consistent for several years."

The awesomeness of reaching a million-dollar TFSA balance is highlighted by the fact that total TFSA contribution room for 2009 through 2016 totals just $46,500. You have to grow this amount by more than 20 times to get to a balance of $1-million.

Aggressive stock trading is how this money was made. Do not try this at home. Instead, your million dollar TFSA will be built through a disciplined approach that puts stock market risk to work in a controlled way (see sidebar). You will not be day trading and swinging for home runs.

In fact, an aggressive approach is likely to draw the attention of CRA as part of its efforts to identify professional stock traders using TFSAs to avoid paying taxes on gains made through a trading business. The CRA spokesman said the factors the agency looks for with TFSAs are high dollar amounts, a high volume of trading transactions and incorrect valuation of the assets in the account.

A key step in building a million-dollar TFSA is to contribute the maximum every year. The maximum for 2016 is $5,500, the same as 2014. The limit jumped to $10,000 last year as the previous Conservative government delivered on a 2011 election promise to double the TFSA when the federal budget was balanced. The new Liberal government rolled the limit back to $5,500 for this year, but will resume the practice of increasing it along with inflation over the years ahead in increments of $500.

We've estimated inflation at 2 per cent on average and calibrated future increases in the limit accordingly in our calculator. Keeping up with these increases will help move you along towards $1-million, but there other important factors as well.

One is your investment approach. The sample investment portfolio provided here to help you build a million dollar TFSA assumes a 5.5 per cent average annual rate of return. For that, you must invest mostly in stocks.

The age at which you start your journey toward a $1-million balance is also crucial. The oldest financial advice in the world is to start young as an investor, but we have to be realistic about this. With a slow-growing economy, it's a challenge to find a job at a young age that pays enough to leave money left over for saving after paying living costs.

We needn't rush things. Our calculator demonstrates that starting at age 30 means you can reach more than $1-million by age 70, assuming the 5.5 per cent returns from our sample portfolio. Shouldn't we expect to be in retirement at that stage and therefore not contributing to TFSAs anymore? With longer lifespans and declining pension coverage in the workplace, it's quite possible that today's 20-somethings will work until age 70.

The stock markets are one risk to achieving a million-dollar TFSA. Recent days remind us how there are unavoidable short-term setbacks on the way to long-term gains. One of these market declines late in your TFSA could postpone your arrival at the $1-million mark.

Another risk is that the federal government will decide in the future that it doesn't want a proliferation of million-dollar tax-free accounts. "In 20 or 30 years, many regular people investing well will get to the million and even $2-milion mark, possibly," said Rhys Kesselman, a professor of public policy at Simon Fraser University.

The foregone revenue from having this money compound tax-free in TFSAs is significant, but Prof. Kesselman said it's affordable. The optics of million-dollar TFSAs may not be. He sees the possibility of criticism of TFSAs on the basis that only the wealthy can benefit. "Who is able to put the $5,500 into a TFSA year after year, starting relatively young in adult life and keep it going?"

A remedy suggested by Prof. Kesselman is a lifetime limit on the amount of money in TFSAs, say $500,000 or $750,000. There could also be a limit on total lifetime contributions.

TFSAs are a very popular program, so there would be a political cost to changes that restrict use of these accounts. Moreover, with the contribution limit recently lowered by the federal government, TFSAs now appear to be on a sound footing. For investors who start early and stay patient, they're the surest way to a tax-free $1-million.

How to build a million dollar TFSA

You don't have to be an investing genius to build a million dollar TFSA. All you need is an online brokerage account and just three exchange-traded funds – which are cousins to mutual funds that trade like a stock. Invest the maximum TFSA amount in this trio of ETFs every year and you end up with more than $1-million in 40 years if you make the projected average annual return of 5.5 per cent.

This million dollar TFSA strategy was suggested by Justin Bender and Dan Bortolotti of PWL Wealth Management. It's a simple approach, though not without risks. One is the suggested 75 per cent weighting in stocks, compared to just 25 per cent in bonds. Stocks have been mostly terrible in the past 12 months, and there will be more downturns like this to come.

Also, a portfolio heavy in stocks may not be suitable for people approaching retirement. A lot depends on whether you also have a pension or other investments with a more conservative mix.

The good news for TFSA-builders that there's an opportunity right now to start your million-dollar TFSA by buying stocks at reduced prices. "I'd say it's a perfect time to start investing," Mr. Bender said. "Things are cheaper than they were a year ago. And what's the alternative, really? You could co cash or guaranteed investment certificates, but the expected returns from stocks looking ahead are higher."

Mr. Bender warns that it's easy to become frustrated at the lack of dramatic progress in the early years of this strategy. By his analysis, someone making maximum contributions for 40 years and earing 5.5 per cent annually would be far short of the goal by Year 30. It's in the final decade of saving that the push to $1-million happens.

The ETF strategy

Here's the mix of ETFs Mr. Bender and Mr. Barolotti suggest can lead you to $1-million:

• 25 per cent Vanguard Canadian Aggregate Bond Index ETF (VAB)
• 25 per cent Vanguard FTSE Canada All Cap Index ETF (VCN)
• 50 per cent iShares Core MSCI All Country World ex Canada Index ETF (XAW)