The Tax-Free Savings Account (TFSA) is the best long-term wealth-building vehicle available to Canadians, but most people don’t see it that way.
The Tax-Free Savings Account is one of the only places you can earn a completely tax-free income on your investments. Any interest, dividends, or capital gains within your TFSA will never be taxed. Not now, not in future years, not if you contribute a certain amount, not if you make a withdrawal, n e v e r.
This is unlike other investment vehicles like the Registered Retirement Savings Plan (RRSP), where you don’t pay taxes on the years you contribute but will pay taxes when you make a withdrawal.
Furthermore, you never lose your TFSA contribution room. If you take money out, you can put it back in the following year, making this also one of the most flexible investment tools available.
- 10 Strategies to Max Out Your TFSA Every Year
- How to Calculate Your TFSA Contribution Limit
- How to Build a $1 Million Dollar TFSA
If you don’t yet have a TFSA, now is the time to get one. If you already have one, you might be looking for ways to make the most of it this year. Here’s my list on how to maximize and max out your TFSA, no matter your starting point!
1. Know your TFSA contribution limit
The Tax-Free Free Savings Account has both annual and lifetime contributions limits.
The Tax-Free Savings Account was introduced in 2009, so if you were at least 18 in that year, your total lifetime contribution limit is now $69,500. However, if you were born later than 1991 and therefore turned 18 after 2009, your total lifetime contribution room depends on your age.
Still confused? Here’s an in-depth explanation of how to calculate your TFSA contribution limit.
It’s important to know your contribution room, so you can save accordingly. If you haven’t yet maxed out your TFSA, you can contribute extra this year to catch up. If you’re at or near your contribution limit, be careful to avoid over-contributing, as there are penalty fees.
If you make a withdrawal from your TFSA in 2020, that amount (along with the next year’s contribution room) will be added back as available contribution room in 2021.
2. Open more than one TFSA
This might seem like an odd suggestion if only because most people don’t know they can have more than one TFSA, but having more than one TFSA can make sense depending on your financial goals.
If the Tax-Free Savings Account is the only place you’re currently saving, you’ll want to have both cash and investments under the TFSA umbrella. For example, it might make sense to have a TFSA savings account for something like your Emergency Fund, as well as a mutual fund or brokerage account for your long-term retirement savings.
You can have as many TFSAs as you want, but you still have to adhere to the total annual and lifetime contribution limits. This means if you open two Tax-Free Savings Accounts, your total contribution room for 2020 is still $6,000. Likewise, your lifetime contribution room remains the same according to your age as calculated in the table above. Make sure to add up the sum in all your TFSAs to make sure you’re staying within your limits.
3. Invest within your TFSA
Most people don’t know, but you don’t have to save in your TFSA. You can use it to invest.
This isn’t readily obvious because the account is called “Tax-Free Savings Account”, but the truth is, your TFSA doesn’t have to be a savings account. You can (and should) buy investments like GICs, stocks, bonds, ETFs, mutual funds, and more under the Tax-Free umbrella.
With current interest rates on savings account hovering around 1% or less, the tax-free benefits of this investment vehicle are not being maximized if you leave your cash in a savings account. By purchasing higher-return investments like mutual funds or stocks, your investment will grow faster and you’ll really reap the rewards of tax-free gains.
I invest using Questrade, which is an online discount brokerage. This is the perfect option if you’re comfortable managing your own investment portfolio. They charge very low fees for stock trades, and it’s free to buy ETFs.
By reducing the trading commissions in my portfolio, the more money stays in my account. There’s no point in saving money on taxes only to spend it on trading fees. Questrade adds even more power to your TFSA.
Not ready to manage your own investment portfolio? Wealthsimple is the right fit for a hands-off investing experience. All you need to do is open account, put some money in, and they’ll take care of the rest.
4. Use your TFSA for building wealth, not planned spending
If you’re using your TFSA to save for vacations or consumables, you’re wasting its power. This is a place to earn tax-free investment income.
Don’t use your TFSA to “save” money that you plan to spend. This defeats the power of the account. Instead, consider the money in your Tax-Free Savings Account off-limits as soon as you make a deposit. In other words, every penny you put into this account should stay there.
One of the best ways to keep your hands out of your TFSA when the temptation to spend comes up is to keep your TFSA at a different institution than your primary bank. This way, when you log on to your online banking to manage your regular spending, you don’t see your savings balance tempting you to make a withdrawal.
5. Devote an income stream to growing your TFSA
To max out this year’s contribution room of $5,500, you’ll need to save $458.33 per month. With high costs of living, huge debt loads, and other financial obligations, it’s not easy for most people to find a spare $458 to tuck away each month.
To overcome this, one of the best things you can do is find a side hustle income to fund your TFSA so you don’t have to budget the cash from your regular paycheque. This might be something like part-time job or hobby, or doing something simpler like if you serve tables, banking your paycheque and putting all your tips in your TFSA.
Better yet, when you file your income taxes this year, put your income tax refund in your Tax-Free Savings Account!
Even if you can’t max out your TFSA this year (or any year), don’t beat yourself up. You can catch up in future years, but more importantly, earning tax-free returns on any amount is better than $0. Saving $2,000 or $1,000 or even $500 is still worthwhile, so don’t make excuses or procrastinate getting started until you have more money.
The Tax-Free Savings Account (TFSA) is a poorly-named, misunderstood golden investment unicorn for Canadians, but only if they use it right. Learn your limit, open an account, and start saving. You’ll thank yourself by next year!