Using Your TFSA Correctly

frustrated-businessman

January 1st brought in the New Year. Along with the parties, the boozing, and the fun it was also the first day when you could top up your TFSA account with new contributions. Since 2009, the Tax Free Savings Account has been around to allow Canadians to save and make investments grow completely tax free. To this day though, many Canadians still don’t understand what a TFSA is and how it should be used for investment purposes. In my opinion, I find it very sad that many Canadians choose to use their TFSA as an everyday chequing account or for a high interest savings account for their GIC investments rather than taking advantage of the tax free nature of the account.

Contribution Limit

Just like the RRSP accounts that everyone is familiar with, the TFSA has a contribution limit, but unlike an RRSP account it is not tied to your annual income. Since it’s inception from 2009 to 2012, the amount was limited to only $5000 a year. Since 2013, the limit has been raised to $5500 to adjust for inflation. This means the maximum amount that one can contribute to the TFSA account since it’s inception is $36500. Regardless if you’re rich or poor, we all start with the same contribution room.

The $5500 limit per year cannot be exceeded. If you do exceed this amount then you will be penalized by the government and taxed on any additional amounts that was put into the TFSA account.

Using a TFSA as a chequing account is even worse because of the rules surrounding contributions. If money is taken out and put back in at a later date, that second contribution counts as new money. For example, after contributing $100, you decide to take it out. After you save that money again you put it back in. The money contributed is not $100, but it’s $200 for the year. How much you contribute in a year is not dependent on how much money is sitting in the TFSA account, but how much money was put in during the calendar year.

Many people make this mistake and don’t realize that they are over contributing. If you take money out you are allowed to replace that money, but the additional contribution room is not applied to the current year, but the following year. The best thing to do is to not use your TFSA as a chequing account, but rather view it as a long term investment account.

Gains Are Tax Free

Like the name of the account states, all gains made in the TFSA account are tax free. It doesn’t matter if the gains are from interest, dividends or capital gains. Any money you make from the TFSA cannot be taxed by any levels of government.

This is different from an RRSP account because when you retire and decide to take money out of the RRSP, it will get taxed by the government. Remember that an RRSP account is a tax deferral account. If you use the TFSA account as a retirement strategy, then you will never pay taxes on any gains that you make inside your TFSA. This is the one of the few ways for individuals in Canada to legally make money tax free in Canada. Use it!

Use It For Growth

Since all gains are tax free in a TFSA, you can think of every dollar made in the TFSA account as the equivalent of 2 dollars earned working. We all know that Canadians are heavily taxed when it comes to income taxes. It’s important to use your TFSA on assets that will grow over time to see the maximum benefits a TFSA account. I see so many individuals make the mistake of using their TFSA as a high interest savings account.

Investing in GICs is a complete waste of your money’s potential in a TFSA. In order to build wealth, you must use your savings to generate additional wealth. With the contribution room approaching almost $40000, the TFSA makes a great brokerage account that can be used to build a diversified portfolio that will grow over time.

Imagine this. A portfolio worth $36500 that is invested now with a compound average annual growth of 7% over 30 years will be worth over $277 847. All these gains are completely tax free. So who doesn’t want over $200 000 of tax free gains?

I always hear that it’s impossible to get 7% gains, but have you tried? Note that I wrote compound average annual growth and did I mention 30 years as well? Over the 30 year time frame, there will be good years and bad years, there may even be a significant crash, but over the time span of 30 years things tend to normalize. There is no easy way to make quick money. It takes time and patience.

Personally over the last 7 years, where we’ve experienced one of the largest stock market bull runs ever, I’ve averaged a return of greater than 10% with a conservative portfolio. This doesn’t mean that great times will continue forever, but I’m really only aiming for an annual average of 7%. Even if I were to experience a few years of poor returns, I’m certain that over 30 years I’ll be up. There is no reason why any one else couldn’t duplicate my success if they have the time and patience.

Get Started Now

If you haven’t started investing using your TFSA, then get one right away. I can’t fathom why Canadians like to defer their taxes using an RRSP account, but wouldn’t like tax free gains.

There is a reason why people with wealth pay very little in taxes. It’s because they understand the investment vehicles that are provided to them and they know how to take advantage of them. The TFSA wasn’t created to only help the rich, it’s just that the ignorant don’t know how to use it. Which camp do you fall under?

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3 thoughts on “Using Your TFSA Correctly

  1. Pingback: Using Your RRSP Correctly « Financially Yours

  2. Pingback: Know Your Limit, Invest Within It « Financially Yours

  3. Pingback: Do The New Policies Hurt Or Help You? | Financially Yours

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