The Tax-Free Savings Account (TFSA) is the best long-term savings vehicle available to Canadians, but less than 40% of eligible savers are making use of it. If you don’t have one, it’s time for you to open a TFSA.
Opening a TFSA is actually very straightforward. All you need to do is select a financial institution and have your Social Insurance Number (SIN) handy. But before you sign up, here’s a crash course in what the TFSA and how to make it work for you.
How the TFSA works
The Tax-Free Savings Account (TFSA) is a registered account introduced in 2009 by the Government of Canada to help Canadians save money. Unfortunately, most people don’t know how it works. When the TFSA was first introduced, I was so intimidated by the acronym, I didn’t open one. It wasn’t until a few months later when I learned how it worked that I finally set up my first TFSA. I imagine many people can tell the same story!
Nevertheless, the TFSA is amazing. When you put money into a TFSA, any income it earns through interest, dividends, or capital gains is tax-free. Yes, you pay NO TAXES on this income!
Any Canadian over the age of 18 can open a TFSA. The annual contribution room is currently $5,500 per year, but you are entitled to all the contribution room for previous years that you were 18 or older, too. This means even if this is the first year you open a TFSA, you can play “catch up” on years you did not contribute.
Here’s a quick table detailing how much contribution room you have in your TFSA based on your age:
Busting myths about the TFSA
There are two things you need to know before you open a TFSA:
The name “Tax-Free Savings Account” is wrong
Tax-Free Savings Account is a misleading name because it implies that this must be a savings account. It doesn’t. You can have a TFSA mutual fund, GIC, or even brokerage account where you buy stocks, bonds, and ETFs. What kind of TFSA you choose depends on your personal financial knowledge, skills, and goals!
You can have as many TFSA’s as you want
You have to stay within your lifetime TFSA contribution limit, but you don’t have to have only one TFSA. Because the TFSA is such a versatile account, you might need more than one to meet different goals. It’s ok to have one cash TFSA for your emergency fund, and one TFSA invested in the stock market for retirement. It’s your money, make sure it’s working for you!
How to use the TFSA
The best thing to open a TFSA for is to save for retirement, but you don’t have to. In fact, you can open a TFSA to save for whatever you want.
Many people use their TFSA to save up for big purchases, like a down payment on a home. Others use it as a place to keep their Emergency Fund or even save up for a vacation. Unlike the Registered Retirement Savings Plan (RRSP) or Registered Education Savings Plan (RESP), there are no rules about how or when you withdraw money from your TFSA. This makes it easy to manage and use in whatever way fits your life best.
However, it is worth noting that the best way to make the most of your TFSA is to earn the most tax-free income, and that entails not spending the money in this account. After all, your money cannot earn interest, dividends, or capital gains if you spend it! This is why the Tax-Free Savings Account is such a powerful retirement savings tool. Unlike the RRSP, there are no taxes to worry about when you contribute or when you make a withdrawal in retirement.
Try to make your TFSA a long-term savings vehicle that helps you grow your net worth over your lifetime, rather than a place where you stash some cash before your next backpacking trip.
Why you need to invest in your TFSA
Saving money is great, but investing money is better. It’s only through investing that you can really tap into the TFSA’s true power. After all, you want the most tax-free income possible, and the highest return is in the stock market.
For this reason, you want to make your Tax-Free Savings account an investment account. Choose something better than a savings account, ideally self-directed or robo-advisor account. Instead of merely earning 1% (or less!) in interest in a savings account, you’ll be able to earn dividends and capital gains on your investments. All of this income in your TFSA is tax-free.
If investing makes you too nervous despite the potential for higher returns, at least choose a mutual fund or GIC. Both of these options typically offer higher returns than a savings account. Remember, you’re looking to make the most money possible since this investment income is 100% tax-free.
The best places to open a TFSA
Pretty much any bank will help you open a TFSA, but some options are better than others. In order to get the best bang for your buck, make sure to comparison shop before you commit. Here are some of the best TFSA options in Canada:
Wealthsimple is perfect for people who know the stock market is the best place to invest their TFSA, but don’t feel confident picking and choosing stocks themselves. Even if you know how to invest, you might want to put some “lazy money” here, so it can grow without worry. I just signed up for Wealthsimple, and now you can get your first $10,000 managed free (which means even more in your TFSA!) by clicking here.
Want to stay out of the stock market for now? You can choose a TFSA mutual fund, savings account, or GIC with Tangerine. I’ve had a TFSA with Tangerine for nearly 10 years, and I love their high-interest rates on savings. I’m also a fan of their no-fee chequing, so that might be worth checking out if you’re tired of paying bank fees. You can earn up to $150 in bonuses by clicking here, which is a perfect amount to use to start your TFSA!
If you’re already investing-savvy and simply want to finally maximize your TFSA’s power, a self-directed portfolio at a discount brokerage is your best option. I have been a client of Questrade since I started investing, and I love their low-fee structure for trading stocks and ETFs. Questrade also offers hands-off portfolios, so if you want to manage some of your money yourself and leave the rest of it up to someone else, you can do both all in one place.
Financial acronyms can be confusing, and the TFSA is no exception. Now you know what those letters stand for, how it works, and how much contribution room you have for your own savings. The TFSA can only do its work for you if you have one! So if you haven’t done so yet, open a TFSA and start making tax-free progress towards your financial goals.